Principles of Account

Handout
Bad debt

A bad debt expense is recognized when a receivable is no longer collectible because a customer
is unable to fulfill their obligation to pay an outstanding debt due to bankruptcy, negligence or
other financial problems.

An entity may not be able to recover its balances outstanding in respect of certain receivables.
We refer to such receivables as Irrecoverable Debts or Bad Debts. Bad debts could arise for a
number of reasons such as customer going bankrupt, trade dispute or fraud

Every time an entity realizes that it unlikely to recover its debt from a receivable, it must ‘write
off’ the bad debt from its books. This ensures that the entity’s assets (i.e. receivables) are not
stated above the amount it can reasonably expect to recover which is in line with the concept of
prudence.

Accounting entry required to write off a bad debt is as follows:

Debit Bad Debt Expense

Credit Receivable

The credit entry reduces the receivable balance to nil as no amount is expected to be recovered
from the receivable. The debit entry has the effect of cancelling the impact on profit of the sales
that were previously recognized in the income statement.

Example
ABC LTD sells goods to DEF LTD for $500 on credit on Jan 1, 2020. On Feb 29, 2020, ABC
LTD subsequently finds out that DEF LTD is being liquidated (bankrupt or closing down) and
therefore the prospects of recovering its dues are very low.

ABC LTD should write off the receivable from DEF LTD in view of the circumstances. The
double entry will be recorded as follows:
JOURNAL ENTRIES

Debit Bad Debt Expense $500

Credit DEF LTD (Receivable) $500

LEDGERS

Sales Ledger

DEF LTD A/C

Date Details $ Date Details $
50 50
Jan-20 Sales 0 Aug-31 Bad Debt 0
     
           

General Ledger

Bad Debt A/C

Date Details $ Date Details $
50 50
Aug-31 DEF LTD 0 Dec-31 Profit & Loss 0
     
           

Profit and Loss A/C

Date Details $ Date Details $
50
Dec-31 Bad debt 0  
     
           

Worked Example:
JOURNAL ENTRIES

Debit: Bad Debt $ 90

Credit: C. Baptise $50

Credit: R. Shaw $40

Bad Debt Recovered
Occasionally, a bad debt previously written off may subsequently settle its debt in full or in part.
In such case, it will be necessary to cancel the effect of bad debt expense previously recognized
up to the amount settlement.

Example

ABC LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently finds out that
DEF LTD is being liquidated and therefore the prospects of recovering its dues are very low.
ABC LTD therefore writes off the receivable from its books. However, the administrator
appointed to oversee the liquidation of DEF LTD instructs the company to pay $300 to ABC
LTD in full settlement of its dues.

As $300 of the bad debt has been recovered, it is necessary to cancel the effect of previously
recognized bad debt expense up to this amount. The accounting entry will therefore be as
follows:

Debit Cash/Bank $300

Credit Bad Debt Recovered (Income) $300

CLASS ACTIVITY:

HOMEWORK:
PROVISION FOR DOUBTFUL DEBTS

What is an Provision/Allowance for Doubtful Accounts?

An allowance for doubtful accounts is a contra-asset account that nets against the
total receivables presented on the balance sheet to reflect only the amounts expected to be paid.
The allowance for doubtful accounts is only an estimate of the amount of accounts
receivable which are expected to not be collectible.

The allowance is established by recognizing bad debt expense on the income statement in the

same period as the associated sale is reported. Only entities that extend credit to their customers
use an allowance for doubtful accounts.

Accounting entries for provision for doubtful debts

1. Creation of Provision for doubtful debts

When a decision has been taken as to the amount of the provision to be made, the
accounting entries needed to record the first provision made are as follow

Debit: Profit and loss account with the amount of the provision
Credit: Provision for doubtful debts account

Example.
At 31 December 2007, the debtors figure after deducting bad debts amounted to
$10,000. It is estimated that 2% of debts (i.e.$200) will eventually prove to be bad
debts, and it is decided and it is decided to make a provision for these. The accounts
would appear as follows:

Profit and Loss A/C

Date Details $ Date Details $
20
Dec-31 Provision for doubtful debt 0  
     
           

Provision for Doubtful Debt A/C

Date Details $ Date Details $
20
    Dec-31 Profit and Loss 0
     
           
These entries would appear in the Final Statements as follows

Profit and Loss Account for the year ended the 31 December 2007 (extract)
  $ $  
Gross Profit XXX  
Less Expenses:  
Provision for doubtful debts 200  
       

Balance Sheet as at 31 December 2007 (extract)

  $ $  
Current assets  
Debtors 10000  
Less: Provision for doubtful debts 200 9800  
       

2. Increase in Provision for Doubtful Debts

When provision created initially needs to be increased, the accounting entries needed
are as follow

Debit: Profit and loss account with the extract amount from the increase
Credit: Provision for doubtful debts account

Example.

At the end of December 2008, the doubtful debt provision needed to be increased
because the debtors’ amount rose to $12000. The estimated provision remained at 2% of
the debtors figure.

Note that the provision of $200 created in 2007 still exists and has been brought forward
to 2008. This $200 needs to be increased to $240 (i.e. 2% of $12000) since the debtors
amount increased. Therefore, all that is needed is a provision of $40.

The account entries would appear as follows:

 Profit and Loss A/C
Date Details $ Date Details $
4
Dec-31 Provision for doubtful debt 0  
     
           

Provision for Doubtful Debt A/C

Date Details $ Date Details $
20
    Jan-20 Balance b/d 0
    Dec-31 Profit and Loss 40
           

These entries would appear in the Final Statements as follows

Profit and Loss Account for the year ended the 31 December 2008 (extract)
  $ $  
Gross Profit XXX  
Less Expenses:  
Increase in provision for doubtful debts 40  
       

Balance Sheet as at 31 December 2008 (extract)

  $ $  
Current assets  
Debtors 12000  
Less: Provision for doubtful debts 240 11760  
       

3. Decrease in Provision for Doubtful Debts

Reducing a provision is the opposite of increasing a provision. When provision initially

created needs to be decreased, the accounting entries needed are as follow

Debit: Provision for doubtful debts account

Credit: Profit and loss account with the amount of the decrease

Example.
For December 2009, the business established the debtors figure had fallen to $10,500. With
the provision still at 2% of debtors the new provision amount would be $210 (2% of
$10,500). All that is needed is for the previous $240, decreased by $30 to $210.

Profit and Loss A/C

Date Details $ Date Details $
Dec-31 Provision for doubtful debt 30
     
           

Provision for Doubtful Debt A/C

Date Details $ Date Details $
24
Dec-31 Profit and Loss 30 Jan-20 Balance b/d 0
21
Dec-31 Balance c/d 0  
           

These entries would appear in the Final Statements as follows

Profit and Loss Account for the year ended the 31 December 2009 (extract)
  $ $  
Gross Profit XXX  
Add other revenue:  
Reduction in provision for doubtful debts 30  
       

Balance Sheet as at 31 December 2009 (extract)

  $ $  
Current assets  
Debtors 10500  
Less: Provision for doubtful debts 210 10290  
       

Class Activity #1

At 31 December 2018, the debtors figure after deducting bad debts amounted to $15,000. It is
estimated that 5% of debts will eventually prove to be bad debts, and was decided by the
accounting team to make a provision for these. By the end of 2019 however, the amount of
debtor increased to $25000. The 5% provision remained in place.

Required:
a) Prepare the ledgers for the above transaction
b) Prepare the Final Accounts (Profit and Loss and Balance Sheet) Extracts

Class Activity #2

On 30 September 2007 B. Fraser’s debtors totaled $12,000 and the following debts were found
to be bad. Fraser decided to write them off:

● G. Green $60
● H. Winston $80
He further decided to make a provision for doubtful debts of 10% on the remaining debtors. On
30 September 2008, Fraser’s debtors totaled $10,000 and it was decided to maintain the
provision of 10%.
Required:
a) Prepare the bad debt and receivables (debtors) account.
b) Prepare the provision for doubtful debt account for 2007 and 2008
c) Prepare the profit and loss account extract for 2007 and 2008
d) Prepare the balance sheet extract for 2007 and 2008
Homework assignment
ABC LTD has trade receivable (debtors) worth $50,000 as at 31 December 2010. XYZ LTD, a
receivable owing $10,000 to ABC LTD at the year end, has been recently been wound up
(closing down). Consequently, ABC LTD does not expect to recover the amount due from XYZ
LTD. Based on past experience, ABC LTD estimates that 5% of its receivables will default.
Allowance for doubtful debts on 31 December 2009 was $1500.

a) Prepare the bad debt and receivables (debtors) account.

b) Prepare the provision for doubtful debt account for 2009 and 2010
c) Prepare the profit and loss account extract for 2009 and 2010
d) Prepare the balance sheet extract for 2009 and 2010

References

Ammar, Ali. (2020) Accounting for Doubtful Debt Retrieved on October 19, 2020. Retrieved
From: https://accounting-simplified.com/financial/receivables/doubtful-debts/
Tuovila, A. (2019) Allowance for Doubtful Accounts. Retrieved on: October 19, 2020. Retrieved
From: https://www.investopedia.com/terms/a/allowancefordoubtfulaccounts.asp

Tuovila, A. (2020) Bad Debt Expense. Retrieved on: October 19, 2020. Retrieved From:
https://www.investopedia.com/terms/b/bad-debt-expense.asp

Wood, F. & Robinson, S. (2007) Principles of Accounts for the Caribbean 5th edition Pearson
Education Ltd. Harlow, England