Bad debts and Provision for Doubtful Debts

Chapter 13

BAD DEBTS AND PROVISION FOR DOUBTFUL

DEBTS

BAD DEBTS AND BAD DEBTS RECOVERED

BAD DEBTS• A bad debt is an amount owing to a business

which will not be paid by the debtor.• Reason:

– Debtor has disapearred– Debtor gone out-of-business– Debtor unable to pay

• If all reasonable steps to obtain payment have failed, the debt is written off as a bad debt.

ACCOUNTING ENTRIES:

Dr Bad DebtsCr Debtor

With the irrecoverable (unable to be paid) amount of a debt

EXAMPLE 1

• On 1 April 2011, ABC company sold goods for $2,000 to Mr. Lee, $1,500 to Mr. Wong and $3,000 to Mr. Wu.

• On 1 June 2011, Mr. Lee and Mr. Wong paid the company $800 and $1,000 respectively with cheque.

• Later, on 31 Dec 2011 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.

JOURNAL ENTRIESDate Details Fo Dr Cr

2011Apr 1 Mr. Lee

Mr. WongMr. Wu Sales

200015003000

6500

ON 1 APRIL 2011, ABC. COMPANY SOLD GOODS FOR $2,000 TO MR. LEE, $1,500 TO MR. WONG AND $3,000 TO MR. WU.

LEDGER

Date Details Fo $ Date Details Fo $

2011Apr 1 Mr. Lee

Mr. WongMr. Wu

2,0001,5003,000

ABC Co.Sales Acc.


2011Apr 1 Sales 2,000

Mr. Lee


2011Apr 1 Sales 1,500

Mr. Wong


2011Apr 1 Sales 3,000

Mr. Wu


2011Jun 1 Bank

Mr. Lee Mr. Wong

1 800800

1 000

ON 1 JUNE 2011, MR. LEE AND MR. WONG PAID THE COMPANY $800 AND $1,000 RESPECTIVELY WITH CHEQUE.

LEDGER


2011June 1 Mr. Lee

Mr. Wong800

1,000

ABC Co.Cash Book (Bank column only)

Sales LedgerMr. Lee

Mr. Wong


2011Apr 1 Sales 2,000

2011June 1 Bank 800


2011Apr 1 Sales 1,500

2011June 1 Bank 1,000


2011Apr 1 Sales 3,000

Mr. Wu


2011June 1 Bad Debts

Mr.Wong Mr. Wu

3500500

3000

LATER, ON 31 DEC 2011 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.

LEDGER


2011Dec 31 Mr. Wong

Mr. Wu500

3,0003,500

2011Dec 31 Profit & Loss 3,500

3,500

ABC Co.Nominal Ledger

Bad Debts Account


2011Apr 1 Sales 1,500

2011June 1Dec 31

BankBad Debts

1,000500

1,500


2011Apr 1 Sales 3,000

3,000

2011Dec 31 Bad Debts 3,000

3,000

Mr. Wu

Sales LedgerMr. Wong

B. BAD DEBTS RECOVERED• A bad debt recovered arises when a debtor pays

some, or all, of the amount owed, after the amount was written off as a bad debt.

Journal Entries Description

Dr Debtors Cr Bad Debts Recovered

With the debt reinstated in the debtor’s account

Dr Cash/Bank Cr Debtors

With the amount received

ACCOUNTING ENTRIES

EXAMPLE 2 • The following balances were part of the trial

balance of Mr. Chan on 31 December 2012:

$

Debtors 10,000

Bad Debts 1,000

• On 31 December 2012, Mr. Chan received cheques of $ 1,000 from debtors, whose debts had been previously written off as bad debts in the current year respectively. No entry has been made for these transactions


2012Dec 31 Debtors

Bad Debts Recovered

1000

1000

31 Bank Debtors

10001000

ON 31 DECEMBER 2012, MR. CHAN RECEIVED CHEQUES OF $ 1,000 FROM DEBTORS, WHOSE DEBTS HAD BEEN PREVIOUSLY WRITTEN OFF AS BAD DEBTS IN THE CURRENT YEAR RESPECTIVELY. NO ENTRY HAS BEEN MADE FOR THESE TRANSACTIONS

LEDGER


2012Dec 31 Debtors 1,000

ABC Co.Cash Book (Bank column only)

Nominal LedgerDebtors Account


2012Dec 31

31

2013Jan 1

Total to dateBad Debts Rec.

Balance b/d

10,0001,000

11,000

10,000

2012Dec 31

31BankBalance c/d

1,00010,00011,000

LEDGER

Bad Debts


2012Dec 31 Total to date 1,000

1,000


1,000



1,000

2012Dec 31 Debtors 1,000

1,000

Bad Debt Recovered

BAD DEBTS & BAD DEBTS RECOVEREDIN PROFIT & LOSS ACCOUNT• Continued from Example 2

Mr. Chan

Profit & Loss for the year ended 31 Dec 2012

$ $

Gross Profit xx

Add: Revenues:

Bad Debts Recovered 1000

1000

xx

Less: Expenses:

Bad Debts 1000

(1000)

Net Profit xx

REDUCING THE POSSIBILITY OF BAD DEBTS• Not to sell goods on credit

• Applying credit control

• Taking legal action against the debtor

PROVISION FOR DOUBTFUL DEBTS

A provision for doubtful debts is an estimate of the amount which a business will lose in a financial year because of bad debts.

Considerations in deciding the amount of provision:◦ Looking at each individual debtor’s account◦ Estimating on the basis of past experience◦ Considering the length of time debts have been

outstanding

Provision for Doubtful Debts

Creating a ProvisionDr Doubtful Debts Cr Provision for

doubtful debts

With the amount of provision for doubtful debts created.

Increase in provisionDr Doubtful Debts Cr Provision for

Doubtful debts

With the increase in the amount of provision for doubtful debts.

Decrease in provisionDr Provision for Doubtful

Debts Cr Doubtful Debts

With the decrease in the amount of provision for doubtful debts.

Accounting entries

Example 3:◦ Sachin’s financial year ends on 31 December.◦ During the year ended 31 December 2004 he

wrote off bad debts totalling $ 950.◦ On 31 December his debtors owed $ 25,000. He

decided to create a provision for doubtful debts of 4 % of the debtors.

A. Creating Provision

Date Details Fo Dr Cr2004Dec 31 Doubtful Debts

Provision for doubtful debts

'1,000*

1,000*

Journal entriesOn 31 December 2004, his debtors owed $ 25,000. He decided to create a provision for doubtful debts of 4 % of the debtors.

*) 1,000 = 4% x $ 25,000

Date Details Fo $ Date Details Fo $2004Dec 31

Total to date 950950

2004Dec 31 Profit &

Loss950950

LEDGER

SachinNominal Ledger

Bad Debts Account


Prov. for Doubtful Debts 1,000

1,000

2004Dec 31

Profit & Loss

1,000

1,000

Doubtful Debts Account


Balance c/d 1,000

1,000

2004Dec 31

2005Jan 1

Doubtful Debts

Balance b/d

1,0001,000

1,000

LEDGER

Provision for Doubtful Debts Account

SachinProfit & Loss Account for the year ended

31 Dec 2004

Gross Profit xxAdd: Revenues xxxxLess: Expenses: Bad Debts 950 Doubtful Debts 1,000 (1,950)Net Profit xx

Final Accounts

SachinBalance Sheet at 31 December 2004

Final Accounts

Fixed Assets xx

Current AssetsDebtors 25,000Less: Provision for Doubtful Debts (1,000)

24,000

Capital xx

Long Term Liab. xx

Current Liab. xx

Continued from example 3:◦ On 31December 2004, Sachin created a provision

for doubtful debts of $ 1,000.◦ During the year ended 31 December 2005, Sachin

wrote off bad debts totalling $ 990.◦ On 31 December 2005, his debtors owed $

28,000. He decided to maintain the provision for doubtful debts at the rate of 4 % of the debtors.

B. Increasing a Provision

Date Details Fo Dr Cr2005Dec 31

Doubtful Debts Provision for

doubtful debts

120*

120*

Journal entries

On 31 December 2005, his debtors owed $ 28,000. He decided to maintain the provision for doubtful debts at the rate of 4 % of the debtors.

*) (4 % x $ 28,000) - $ 1,000


Total to date 990990

2005Dec 31 Profit &

Loss990990

LEDGER


Bad Debts Account


Prov. for Doubtful Debts 120

120

2005Dec 31

Profit & Loss

120

120



2005Dec 31

Balance

Balance

c/d

c/d

1,000

1,000

1,120

1,120

2004Dec 31

2005Jan 1Dec 31

2006Jan 1

Doubtful Debts

BalanceDoubtful Debts

Balance

b/d

b/d

1,0001,000

1,000

1201,120

1,120

LEDGER



31 Dec 2005

Gross Profit xxAdd: Revenues xxxxLess: Expenses: Bad Debts 990 Doubtful Debts 120 (1,110)Net Profit xx

Final Accounts


Final Accounts

Fixed Assets xx

Current AssetsDebtors 28,000Less: Provision for Doubtful Debts (1,120)

26,880

Capital xx

Long Term Liab. xx

Current Liab. xx

Continued from example 3:◦ On 31 December 2005, Sachin’s provision for

doubtful debts amounted to $ 1,120.◦ On 31 December 2006, his debtors owed $

24,000. He decided to maintain the provision for doubtful debts at the rate of 4% of the debtors.

C. Reducing a Provision

Date Details Fo Dr Cr2006Dec 31

Provision for doubtful debts Doubtful Debts

160*

160*

Journal entries

On 31 December 2006, his debtors owed $ 24,000. He decided to maintain the provision for doubtful debts at the rate of 4% of the debtors.

*) 1,120 – (4 % x $ 24,000)

LEDGER




Profit & Loss 160

160

2004Dec 31

Prov. for Doubtful Debts 160

160


2005Dec 31

2006Dec 31

31

Balance

Balance

Doubtful DebtsBalance

c/d

c/d

c/d

1,000

1,000

1,120

1,120

160

9601,120

2004Dec 31

2005Jan 1Dec 31

2006Jan 1

2007Jan 1

Doubtful Debts

BalanceDoubtful Debts

Balance

Balance

b/d

b/d

b/d

1,0001,000

1,000

1201,120

1,120

1,120

960

LEDGER



31 Dec 2006

Gross Profit xxAdd: Revenues: Reduction in Provision for Doubtful Debts 160160xxLess: Expenses: (xx)Net Profit xx

Final Accounts


Final Accounts

Fixed Assets xx

Current AssetsDebtors 24,000Less: Provision for Doubtful Debts (960)

23,040

Capital xx

Long Term Liab. xx

Current Liab. xx

Documents

Bad debts and Provision for Doubtful Debts