ACCOUNTING FOR BAD DEBTS | Accounting | NTA NET Paper 2

Sundry Debtors

The sum total or aggregate of the amounts, which the customers owe to the business for purchasing goods on credit, is known as Sundry Debtors, or Trade Debtors, or Book Debts or simply Debtors. These sundry debtors may again be classified as under:

• Good Debt: The debts which are sure to be realized are called Good Debt.
• Doubtful Debts: The debts which may or may not be realized are called Doubtful Debts.
• Bad Debts: The Debts which cannot be realized at all are called Bad Debts or Unrealizable or irrecoverable Debts.

Bad Debts

It is an amount which is written off by the business as a loss to the business and considered as an expense because the debtors of the business have turned to be bad and now no amount could be collected from them any more even after making all reasonable efforts. This usually occurs when the debtor has been declared bankrupt or the cost of pursuing further action in an attempt to collect the debt exceeds the debt itself.

The accounting process is that the debtor’s account is immediately written off by crediting the debtor’s account and this writes off any balance remaining in the account of debtor. A bad debt represents the loss of income that is why it is regarded as an expense.

The following entries are required to be passed:
(i) For actual bad debt (if there is no provision for bad debts)
Bad Debts A/c Dr.

To Sundry Debtors A/c
(Profit & Loss A/c Dr.
To Bad Debts A/c

(ii) For actual bad debts (if there is an existing provision i.e., old reserve)
Provision for Bad Debts A/c Dr. (Actual amount)
To Bad Debts A/c
Thus, for Final Accounts:
Bad Debts –
(iii) If only within the Trial Balance: To be debited to Profit & Loss A/c
(iv) If outside the Trial Balance: To be debited to Profit & Loss A/c

(i.e., in the adjustment) And, to be deducted from Sundry Debtors in the Balance Sheet

Provision Reserve for Bad Debts

Doubtful debts are those debtors from whom the chances of getting the payment are very low. There may be many reasons for non-payment that may be able to include disputes over supply, delivery, and conditions of goods, the appearance of financial stress within customers operation. In the business whenever such a dispute occurs it is very sensible to add this debt or portion thereof to the doubtful debt reserve. This is based on the principle of conservatism and this is done to avoid over-stating the assets of the business as trade debtors is reported net of Doubtful debt.

Accounting Steps
To sum up, the following entries are required to be passed for Bad Debts and Provision for Bad Debt:

(a) Whenever provision is made for the 1st time (at the end of the first year)
(i) Bad Debts –
Profit & Loss A/c Dr. (With the actual amount)
To Bad Debts A/c
(ii) For creating provision for Bad debts –
Profit and Loss A/c Dr.

To Provision / Reserve for Bad Debts A/c (With the amount of further provision)
(b) At the end of subsequent year –

(i) For Bad Debts –
Profit & Loss A/c Dr. (With the actual amount)
To Bad Debts A/c
(ii) Then the next year’s provision is estimated which is carried forward and the extra or excess provisions are adjusted (against the old provision) which is transferred to Profit & Loss Account, that is, the entry will be –
Profit and Loss A/c Dr.
To Provision / Reserve for Bad Debts A/c (With the amount of further provision)

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