Bad debts and Provision for Bad debts

Bad DebtsWhen 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 DebtsCr Debtor

With the irrecoverable amount of a debt

ExampleDuring 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 respectivelyLater, 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$ $

Bank 800

Mr. Wong$ $

Sales 1,500

Bank 1,000

Sales 2,000

2,000 2,000

Balance c/f 1,200

Bad Debts 500

Mr. Wu

$ $Sales 300 Bad Debts 300

Bad Debts

$$

Mr. Wong 500

Mr. Wu 300

P/L 800

800 800

1,500 1,500

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 LossCr Provision for Bad

Debts

With the increase in the amount of provision for bad debts

2. 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 Debts1994 $ 1994 $

Dec 31 Balance c/d 5,000

($50,000 * 10%)

Dec 31 Profit and loss 5,000

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

Gross profit

Less: ExpensesIncrease in provision for bad debt 5,000

$X

$

Balance Sheet as at 31 December (Extract)

1994

Current Assets1994

DebtorsLess: provision for bad debt

50,000

5,00045,000

Provision for Bad Debts1994 $ 1994 $

Dec 31 Balance c/d 5,000

($50,000 * 10%)

Dec 31 Profit and loss 5,000

1995Dec 31 Balance c/f

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

1995Jan 1 Balance b/d 5,000

Dec 31 Profit and Loss 1,000

6,000 6,000

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

Gross profit

Less: ExpensesIncrease in provision for bad debt 5,000

$X

$

1994 1995

$ $X

1,000

Balance Sheet as at 31 December (Extract)

Current Assets1994

DebtorsLess: provision for bad debt

50,000

5,00045,000

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 Debts1994 $ 1994 $

Dec 31 Balance c/d 5,000

($50,000 * 10%)

Dec 31 Profit and loss 5,000

1995Dec 31 Balance c/f

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

1995Jan 1 Balance b/d 5,000

Dec 31 Profit and Loss 1,000

6,000 6,000

1996 $ 1996 $

6,000

Jan 1 Bal b/f 6,000Dec 31 Profit and Loss 2,000

6,000

31 Balance c/f

($40,000*10%) 4,000

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

Gross profit

Less: ExpensesIncrease in provision for bad debt 5,000

$X

$

1994 1995

$ $X

1,000

1996$ $

X Add: Decrease in provision for bad debts 2,000

Balance Sheet as at 31 December (Extract)

Current Assets1994

DebtorsLess: provision for bad debt

50,000

5,00045,000

1995

60,0006,000

54,000

1996

40,000 4,000

36,000

C. Bad Debts RecoveredBad debts recovered refers to debts formerly written off to be recovered later.

Accounting entries

Dr DebtorsCr Bad Debts

Recovered

With the debt reinstated in the debtor’s account

Dr Cash/BankCr Debtors

With the amount received

Dr Bad Debts Recovered

Cr Bad DebtsORDr Bad Debts

RecoveredCr Profit and Loss

With the debt written off in this year to be recoveredORWith 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

Bank1996 $

Dec 31 Debtors 1,500 Debtors

1996 $

Dec 31 Bal b/d 10,000

1996 $

Dec 31 Bank 1,500Dec 31 B.D.R. 300

Dec 31 B.D.R. 1,200 Bad Debt

1996 $

Dec 31 Bal b/d 1,0001996 $Dec 31 B.D.R. 300Dec 31 P & L 700

Bad Debt Recovered1996 $

Dec 31 P & L 1,200

1996 $

Dec 31 Debtors 300Dec 31 Bad Debt 300

Dec 31 Debtors 1,200

1,000 1,000

1,500 1,500

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

Gross profit

Less: Expenses

Bad Debt 700

1996$ $

X Add: Bad Debt Recovered 1,200