How to do bad debts adjustment in final accounts?

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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:

(being bad debts written off)

(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:

(being bad debts written off)

Example

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

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;

(being amount irrecoverable from the retailer)

Extract of Profit and loss a/c

Extract of balance sheet