In a business scenario, amounts which are overdue to a business owner by their debtor(s) and are declared irrecoverable are called bad debts. There are few reasons for debtor(s) to not pay their debts on time, for example, a debtor going bankrupt or experiencing hardship due to business losses. This can either be the complete amount owed or a part of the debt. In some cases, the amount may be recovered in future or may completely be lost.
While accounting for b/debts it is treated as a loss to business and reduces the amount of debtors. The full amount should be written off to the “Income statement” of the related period or against the provision for b/debts. They are losses, hence they are debited and debtor’s account is credited.
Journal Entry for Bad Debts
|Bad Debts A/C||Debit||Nominal Account||Dr. all losses|
|To Debtor’s A/C||Credit||Personal Account||Cr. the giver|
At the time of preparing final accounts debts which are written off during the period post-finalization of trial balance are transferred to profit and loss account by passing the below journal entry.
|Profit & Loss A/C||Debit|
|To Bad Debts A/C||Credit|
Explanation with Example
Let us assume that Mr Unreal, a sole proprietor, was supposed to pay 1,00,000 on an invoice to ABC Corp. However, he filed for bankruptcy and is declared insolvent. In this case, ABC Corp will go through the following accounting in their books:
At the time of realization (Assuming the opening balance was nil)
|Bad Debts A/C||1,00,000|
|To Mr Unreal A/C||1,00,000|
At the time of transferring the amount to P&L Account
|Profit & Loss A/C||1,00,000|
|To Bad Debts A/C||1,00,000|
Related Topic – What are Non-performing assets or NPA?
Placement Inside Books of Accounts