Debt and Profit
(C) BAD DEBTS, BAD DEBTS RECOVERED AND PROVISION FOR DOUBTFUL DEBTS. Bad debts
Introduction
Customers who buy goods on credit might fail to pay for them, perhaps:
Out of dishonesty,
They have gone bankrupt,
They are incurring losses in their businesses,
Because of unexpected introduction of foreign exchange control restrictions by their country’s government during the credit period (i.e. if they are trading internationally).
They are dead.
In these circumstances, a business might decide to give up expecting payment and to write the debt off as a lost cause. Businesses normally make provisions for such cases.
Provisions are those amounts which are set aside out of the profits for a specific purpose e.g. provisions for bad debts, doubtful debts or depreciation, etc.
These provisions are made in view of some expected events. Any expected loss in the future relating to the current accounting period must be charged (i.e. debited) to the profit and loss account of the current period.
Similarly, any expected gain in the future relating to the current year must be credited to the profit and loss account of the current year.
N.B.
This treatment is essential for calculating correct net profit.
Definition:
A bad debt is one that the business is unable to collect, thus it is written off. Debts due from the debtors are shown as an asset. When a debt becomes irrecoverable, it must be written off as a bad debt; otherwise, the balance sheet will not show a true and fair value of the debtors. This bad debt is regarded a loss to the business.
Accounting treatment:
This is twofold:
(i) Bad debt written off:
DR: Bad debts account.
CR: Debtor’s account.
(ii) At the end of the year:
DR: Profit and loss account.
CR: Bad debt account.
Illustration:
Debtor account
Date
Narration £
Date
Narration £
2011
2011
Jan.1
Balance b/d xx
Mar.20
Bad debts xx
Bad debt account
Date
Narration
Introduction
Customers who buy goods on credit might fail to pay for them, perhaps:
Out of dishonesty,
They have gone bankrupt,
They are incurring losses in their businesses,
Because of unexpected introduction of foreign exchange control restrictions by their country’s government during the credit period (i.e. if they are trading internationally).
They are dead.
In these circumstances, a business might decide to give up expecting payment and to write the debt off as a lost cause. Businesses normally make provisions for such cases.
Provisions are those amounts which are set aside out of the profits for a specific purpose e.g. provisions for bad debts, doubtful debts or depreciation, etc.
These provisions are made in view of some expected events. Any expected loss in the future relating to the current accounting period must be charged (i.e. debited) to the profit and loss account of the current period.
Similarly, any expected gain in the future relating to the current year must be credited to the profit and loss account of the current year.
N.B.
This treatment is essential for calculating correct net profit.
Definition:
A bad debt is one that the business is unable to collect, thus it is written off. Debts due from the debtors are shown as an asset. When a debt becomes irrecoverable, it must be written off as a bad debt; otherwise, the balance sheet will not show a true and fair value of the debtors. This bad debt is regarded a loss to the business.
Accounting treatment:
This is twofold:
(i) Bad debt written off:
DR: Bad debts account.
CR: Debtor’s account.
(ii) At the end of the year:
DR: Profit and loss account.
CR: Bad debt account.
Illustration:
Debtor account
Date
Narration £
Date
Narration £
2011
2011
Jan.1
Balance b/d xx
Mar.20
Bad debts xx
Bad debt account
Date
Narration