Bad debts and Provision for Bad debts

Bad Debts
When the firm finds that it is impossible to collect a debt, that debt should be written off as a bad debt. Accounting Entries:
Dr Bad Debts Cr Debtor With the irrecoverable amount of a debt

Example
During the year, a company sold goods for $2,000 to Mr. Lee, $1,500 to Mr.Wong and $300 to Mr. Wu. Mr. Lee and Mr. Wong paid the company $800 and $1,000 respectively Later, Mr. Wong and Mr. Wu became bankrupt, and it is impossible for the company to collect these debts. The company decided to write these off as bad debts.

Mr. Lee Sales

$ 2,000
2,000

Bank Balance c/f

$ 800 1,200
2,000 $ 1,000 500
1,500

Mr. Wong Sales $ 1,500 1,500 Mr. Wu Sales $ 300 Bad Debts $ 300 Bank Bad Debts

Bad Debts $ 800 800 $ Mr. Wong Mr. Wu 500 300 800 P/L

B. Provision for Bad / Doubtful Debts

A provision for bad and doubtful debts may be made when a firm thinks that there will be problems in recovering a debt.

Accounting entries
1.

Increase in provision

Dr Profit and Loss Cr Provision for Bad Debts

2.

With the increase in the amount of provision for bad debts

Decrease in provision

Dr Provision for Bad Debts Cr Profit and Loss

With the decrease in the amount of provision for bad debts

Increase in provision for bad debts

Example
A firm decided to make a provision for bad debts at 10% of the debtors accounts which totalled $50,000 on 31 December 1994. On 31 December 1995, the debtors accounts totalled $60,000. The firm maintained the provision at 10% of its total debtors.

Provision for Bad Debts

1994 $ 1994 $

Dec 31 Balance c/d ($50,000 * 10%)

5,000

Dec 31 Profit and loss

5,000

Profit and Loss Account for the year ended 31 December (Extract)
Gross profit 1994 $ $ X

Less: Expenses Increase in provision for bad debt 5,000

Balance Sheet as at 31 December (Extract)

Current Assets 50,000 Debtors Less: provision for bad debt 5,000 45,000 1994

Provision for Bad Debts

1994 $ 1994 $

Dec 31 Balance c/d ($50,000 * 10%)

1995

5,000

Dec 31 Profit and loss

1995

5,000

Dec 31 Balance c/f ($60,000*10%) 6,000 6,000

Jan 1

Balance b/d

5,000 1,000 6,000

Dec 31 Profit and Loss

Profit and Loss Account for the year ended 31 December (Extract)
Gross profit 1994 $ $ X 1995 $ $ X 1,000

Less: Expenses Increase in provision for bad debt 5,000

Balance Sheet as at 31 December (Extract)

1994 Current Assets 50,000 Debtors Less: provision for bad debt 5,000 45,000 1995 60,000 6,000 54,000

Decrease in Provision for bad debts

Example
The debtors accounts on 31 December 1996 totalled $40,000. The firm decided to maintain the provision at 10% of the total debtors.

Provision for Bad Debts

1994 $ 1994 $

Dec 31 Balance c/d ($50,000 * 10%)

1995

5,000

Dec 31 Profit and loss

1995

5,000

Dec 31 Balance c/f

($60,000*10%) 6,000 6,000
1996 $

Jan 1

Balance b/d

5,000
1,000 6,000

Dec 31 Profit and Loss

1996

Dec 31 Profit and Loss 31 Balance c/f ($40,000*10%)

2,000 Jan 1 Bal b/f 4,000 6,000

6,000

6,000

Profit and Loss Account for the year ended 31 December (Extract)
1994 $ $ Gross profit X Add: Decrease in provision for bad debts Less: Expenses Increase in provision for bad debt 5,000 1995 $ $ X 1,000

1996
$ $ X 2,000

Balance Sheet as at 31 December (Extract)

Current Assets 50,000 Debtors Less: provision for bad debt 5,000 45,000 1994

1995
60,000 6,000 54,000

1996
40,000 4,000 36,000

C. Bad Debts Recovered

Bad debts recovered refers to debts formerly written off to be recovered later.

Accounting entries
Dr Debtors Cr Bad Debts Recovered Dr Cash/Bank Cr Debtors Dr Bad Debts Recovered Cr Bad Debts OR Dr Bad Debts Recovered Cr Profit and Loss With the debt reinstated in the debtors account With the amount received With the debt written off in this year to be recovered OR With the debt written off in a previous year to be recovered

Example
The following balances were part of the trial balance of Mr. Chan on 31 December 1996:
Debtors $ 10,000

Bad Debts

1,000

During the year, Mr. Chan received $300 and $1,200 from debtors, whose debts had been previously written off as bad debts in the current year and last year respectively. No entry has been made for these transactions

Bank
1996 $

Dec 31 Debtors
1996

1,500 Debtors
$ 1996 $

Dec 31 Bal b/d Dec 31 B.D.R. Dec 31 B.D.R.

1996

10,000 Dec 31 Bank 300 1,200 Bad Debt

$ 1996

1,500

Dec 31 Bal b/d

1,000 Dec 31 B.D.R. Dec 31 P & L 1,000 Bad Debt Recovered

$

300 700 1,000

$

1996

1996

Dec 31 Bad Debt Dec 31 P & L

300 1,200 1,500

Dec 31 Debtors Dec 31 Debtors

300 1,200 1,500

Profit and Loss Account for the year ended 31 December (Extract)

1996
Gross profit Add: Bad Debt Recovered Less: Expenses Bad Debt 700 $ $ X 1,200