Accounting Treatment : Bad Debts & Provision for Bad Debts

What is Bad Debts?

Bad debts is the amount of credit sales which can not be recovered or become irrecoverable are called bad debts. It is considered as the business loss of the company and reduced the accounts receivable amount from the books of accounts.

Journal Entry for Bad Debts

Bad debts is recorded in the books of accounts by making following adjustment entry:

  1. Firstly debtors/receivable A/c to be decreased and the Journal entry will be:
Bad Debts A/cDebit
Sundry Debtors A/cCredit
(Adjustment Entry made for Bad Debts)

2. Secondly Bad debts amounts adjusted with Profit and Loss A/c and the Journal Entry will be:

Profit & Loss A/c (Income Statement)Debit
Bad Debts Accounts A/cCredit
(Bad Debts amount transferred to P/L A/c)

3. If, subsequently the bad debts amounts recovered, the journal entry in this case:

Bank/Cash A/c Debit
Profit & Loss A/cCredit
(Being the recovered is treated as Income)

Treatment in Financial Statement

Income Statement is debited with amount of bad debts and in the Balance Sheet, the Accounts Receivable balance to be decreased by the same amount in the assets side.

What is Provision for Bad Debts

A provision for bad debts is the amount of receivable where the accounts manager feels that certain receivable amount could not be recovered. This is the amount of reserve against future recognition of certain accounts receivable that would not be collectible.

Why Provision for bad debts is the liability!

A provision for bad debts is the probable loss or expenses of the immediate future. But the accountant is unsure when or how much the loss/expenses may occur. A provision for bad debts is the different from the bad debts where the loss or expenses is certain. But in this case all assume according to past records of the business.

As provision for bad debts is the future loss which will be recorded when it incurs. This future loss is like owing someone, hence it is considered as a liability of the business but a special liability.

Types of provision for bad debts

Provision can be made in the following ways:

  • General Provision
  • Specific Provision

General Provision can be made according to the past business trend. No specific debtors are considering. General provision is made as % of closing trade receivables and is usually made on the basis of past trend and future expectation about the receivables and other existing conditions.

Specific provision is made when there is sufficient evidence that may make to believe that a number of receivables may not pay their money. In this case, individual receivable account are critically scrutinized to appraise the trade receivable on individual basis.

However, following points to be taken into consider:

  • Economic condition of the receivables
  • Past track record of the receivables
  • How long receivable turnover period.

Journal Entry with Example

Lets say that, at the year end you have seen that you have RS 15,00,000 in Debtors Control Account. You estimated that you may not able to collect 2% of such balance and decided to make the provision for this un-collectible amount. Hence, you will lose RS 30,000 in future and you have to record this.

The journal entry in this respect is :

Bad Debts (Expenses) A/cDebit
Provision for Bad Debts A/cCredit