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  1. This answer was edited.

    Adjustment in final accounts Adjustment of bad debts is often a tedious task for the students which ultimately leads to an error and false representation of the financial position of the business. They are adjusted in two ways depending on their record in the books of accounts, which is as follows:Read more

    Adjustment in final accounts

    Adjustment of bad debts is often a tedious task for the students which ultimately leads to an error and false representation of the financial position of the business. They are adjusted in two ways depending on their record in the books of accounts, which is as follows:

    1. Treatment of bad debts before preparation of trial balance

    As a debtor fails to pay the due amount his account is credited and closed as well as a new account is opened known as the Bad debts account.

    In the trial balance:
    The net amount of bad debts incurred during the financial period and the Sundry debtors excluding the amount of bad debts appear as a separate item in the Trial balance on the debit side.

    In the Income statement or the Profit and loss a/c:

    Bad debts being an expense are recorded under operating expenses in the income statement or on the debit side of the Profit and loss a/c.

    Journal entries for adjustment of bad debts:

    Bad debts a/cDebit
    To Sundry debtors a/cCredit

    (being bad debts written off)

    Profit and loss a/cDebit
    To Bad debts a/cCredit

    (being bad debts transferred to p/l a/c)

    2. Treatment of bad debts after the preparation of trial balance

    Sometimes the amount of bad debts may be mentioned as an adjustment item outside the Trial balance. These types of debts are often referred to as further bad debts and have not yet been written off. To provide a true financial position of the company it is necessary to include these bad debts while preparing the Final accounts.

    In the profit and loss a/c:

    They are added to the already written off bad debts and appear on the debit side of the profit and loss a/c.

    In the balance sheet:

    They are deducted from the adjusted sundry debtors on the asset side of the balance sheet.

    Journal entry for adjustment of further bad debts:

    Bad debts a/cDebit
    To Sundry debtors a/cCredit

    (being bad debts written off)

    Example:

    The extract of the trial balance of XYZ Ltd. is as follows:

    PARTICULARSDEBITCREDIT
    Sundry debtors50,000 
    Bad debts8,000 

    XYZ Ltd. sells goods to a retailer at 50 days credit. However, after 50 days, the company realizes that the retailer has been declared insolvent and only an amount of 4,000 will be received against the total amount of 8,000. The adjustment in the final accounts is as follows:

    Bad debts a/cDebit4,000Debit all expenses and losses
    To Retailers a/cCredit4,000Credit the giver

    (being amount irrecoverable from the retailer)

    Extract of Profit and loss a/c

    PARTICULARSAMOUNTPARTICULARSAMOUNT
    To Bad debts a/c        8,000   
    (+) further bad debts  4,00012,000  

    Extract of balance sheet

    LiabilitiesAmountAssetsAmount
    Sundry debtors           50,000
    (-) Further bad debts   4,000
    46,000

    Hope this helps.

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  1. This answer was edited.

    As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business. So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the businessRead more

    As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business.
    So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the business and it may arise due to reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts.

    Yes, bad debts are recorded in the Income statement.  The Income statement shows the aggregate financial position of a business during a specified period by displaying the amount of revenue generated and expenses incurred by a business. Bad debts being an expense are recorded under operating expenses in the Income Statement or on the debit side in the Profit & Loss a/c.

    Example

    ABC Ltd. sells goods to a retailer for 40,000 at 50 days credit. However, after 50 days, the company realizes that the retailer has been declared insolvent and the amount is no longer recoverable. This amount of 40,000 is an expense for ABC Ltd and leads to a fall in the accounts receivable.
    The journal entries to be recorded in the books of ABC Ltd are as follows:

    Bad debts a/cDebit40,000Debit the increase in expense
    To Retailer’s a/cCredit40,000Credit the decrease in asset

    (being amounts written off as bad debts transferred to bad debts account)

    Profit and loss a/cDebit40,000
    To Bad debts a/cCredit40,000

    (being bad debts transferred to profit and loss a/c)

    Bad debts as shown in the Income statement

    (Extract of Income Statement)

    PARTICULARSAMOUNTAMOUNT
    Revenue8,00,000
    Expenses:
    COGS50,000
    Insurance expense60,000
    Depreciation expense20,000
    Bad debts expense40,000
    Total Expense1,70,000

    Hope this helps.

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  1. This answer was edited.

    Bad Debts In layman's language, Bad Debt is an expense incurred by a business, which is not repaid by the debtor, in the due course of time for reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts. Meaning of LiabilitRead more

    Bad Debts

    In layman’s language, Bad Debt is an expense incurred by a business, which is not repaid by the debtor, in the due course of time for reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts.

    Meaning of Liability

    Liabilities refer to the financial obligations of a business. In simple words, it is a sum of money owed by a debtor to a creditor under an agreement and repayable on a specified period. For example, Bank Loans, Accounts Payable, Bank Overdrafts, etc.

    Bad debts are an expense or a liability?

    Bad Debts are an expense to the business and not a liability as the amount that was expected to be received from the debtor is irrecoverable and has a negative effect in the books of accounts by way of reduction from the accounts receivable.

    It is recorded on the asset side of the balance sheet however, it is entered in the balance sheet as a contra asset account i.e. as a reduction from the accounts receivable. It is also recorded under operating expenses in the Income Statement as well as in the profit and loss a/c on the debit side.

    Therefore, we can easily conclude now that bad debts are an expense and not a liability.

    This concept is further explained with an example stated below.

    Example

    XYZ Ltd sells machinery to ABC Ltd. for 10,000 at 60 days credit. However, ABC Ltd is declared bankrupt and therefore can no longer pay the specified amount. This amount of 10,000 is an expense for XYZ Ltd and leads to a fall in the accounts receivables. Hence, it is not a liability for the company but an expense.

    Bad debts as shown in the Income statement

    (Extract of Income statement)

    Income statement

    Hope this helps.

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