Well, First of all, there is a Debt. If getting paid in time, it is a Good Debt. And if not got paid, it became Bad Debts.
What is Debt?
The company sells on credit to its customers and allows them some time as a credit period to pay off their dues, which is called a debt owed by a Debtor/purchaser to its Creditor/supplier/provider of service.
What is Bad Debt?
There are some customers/debtors who taken the supplies on credit and after some time due to some reason (maybe the financial problem, litigation with their suppliers, inferior quality than agreed, rejected supplies, etc.) they are not in a position to or will not pay back the dues to their suppliers. The Company/Supplier takes several steps to recover its debt. But even after that, they are unable to recover their debts and will not hope to get them recovered at all.
Thus it became an irrecoverable/non-recoverable amount to the Company/Supplier/Seller. And is classified as a Bad Debts in their books of accounts.
What is Good Debt?
Where there is a hope of recovery of the debt or credit supplies to the Company/Seller is a Good Debt for them.
What is the meaning of Bad Debts written off or bad debts expenses?
The credit sales are the receivables in the books of the company. when these are not recoverable, the company treats and classifies/writes off this as an expense. this process of classifying is called “Bad Debt written off” or “Bad Debt expenses” in books.
Bad Debts Journal Entry :
- Credit sales made by the company are lying in receivable on the Asset side of the Balance Sheet.
- When the receivable became Bad Debts, those needs to written off in books.
- Writing off of Bad Debts means the classification of receivable to Expenses in books of accounts.
- Since receivables are lying on the Asset side of the Balance sheet, those are the balances with the Debit balance.
- Expenses are having Debit Balance and are part of the Profit and Loss Account.
- Therefore the entry will be as below for the identified customers from whom there will not be any recovery.
Bad Debts A/c. Dr.
To Receivables/Customers A/c.
- Sometimes based on the business exposure, Companies predict some per-centage (%) of the receivable may become bad, Companies provide this on an ad-hoc basis without affecting the balance in receivables.
- The additional entry is accounted as below by creating new GL “Provision for Bad Debts” or “Reserve for Doubtful Debts (RDD)” and this GL will be having the Credit Balance and will lie on the Liability Side of the Balance Sheet.
Bad Debts A/c. Dr.
To Provision for Bad Debts / RDD.
- The receivables on the Asset side and the Reserves on the Liability side will be the net position of the receivables in the Books of Accounts.
Is Bad Debts an allowable expense in the calculation of Income Tax?
Yes, it is an allowable expense. But will be taxed if recovered after.
Treatment on the recovery of Bad Debts :
Even after writing off of Bad Debts in books of accounts, Companies will keep on follow-up for recovery and after the recovery, the entry will be accounted as below.
- Recovery of the Bad Debt already written off.
Bank Account Dr.
To Miscellaneous Income/Bad Debt recovery A/c.
- Recovery of the Bad Debt provided for on a per-centage (%) basis. Here the separate provision was made.
Bank Account Dr.
To Customer A/c.
