POA Notes Sept 2013 Bad Debts and Provision For Bad Debts

Bad Debts and Provision for Bad Debts
A bad debt is a debt that a business knows with certainty will not be collected. Once it has been
established that a debt is bad, the debtor (account receivable) is closed of or written of from the ledger.
Sometimes the debtor is only able to pay part of his debt. The unpaid balance on the account is written off
as bad. At the end of the year the bad debts account is closed off to the Profit and Loss Account/Income
Statement as an expense.
Journal and Ledger entries to write off bad debts
Example:
The accountant at Harris Enterprises notes the following:
S. Hall is a debtor who owes $820. She is unable to pay her debt due to bankruptcy. It was decided to
write off her debt as bad on June 1 2008. J. McIntosh owes $980. Due to financial difficulty he is only able
to pay $.40 on every dollar. In July 1 2008 it was decided to write off part of the debt as bad.
Harris Enterprises
General Journal
Details
Date
2008
Jun 1
Jul 1
Bad Debts A/c

S. Hall A/c.
To record bad debts written of
Cash
Bad debts A/c
J. McIntosh
To record bad debts written of after part
Debit
Credit
$
820
$
820
392
588
980
payment
Dec 31
Income statement
Bad Debts A/c
To close of bad debt A/c at the end of the
1 408
1 408
period
Sales Ledger
Date
2008
Details
S. Hall A/c
Amou
Date
nt
2008
Details
Amount
$
Jun 1
Date
Bal. c/d
Details
$
820
Jun 1
J. McIntosh A/c
Amou
Date
2008
nt
2008
Jul 1
$
980
Jul 1
Bal. c/d
Bad debts A/c
Details
820
Amount
$
Cash
Bad debts A/c
980
392
588
980
General Ledger
Date
Details
Bad Debts A/c

Amou
Date
2008
nt
Jun 1
Jul 1
$
820
588
1 408
S. Hall
J. McIntosh
Details
2008
Dec 31 Income statement
Amount
$
1 408
1 408
***At the end of the year, the bad debts account is closed off to the Income Statement
Provision for Doubtful/Bad Debts
Doubtful debts are those which cannot be classified as bad but which experience says will probably go bad
eventually. The amount of doubtful debts to be provided for is determined largely through the experience
of the businessman and the accountant. Some firms simply apply a small percentage to the total of the
accounts receivable.
In an alternative but more acceptable method (the aging debt method), a list is prepared comprising of the
debtors whose payments are overdue for varying periods. After a careful examination of the lost of debtors
with the aging debts, a decision is made to declare a percentage of each category on that list as doubtful.
The firm will apply a larger percentage for older debts.
List of aging debts
Age of Debts
Debtors
Amount Owed
Provision %
9 months
C. Baird
1 200
10%
A. Small
800
6 months
3 months
N. Gray
750
V. Blue
910
F. Ali
460
N. Fish
1 290
5%
3%
At some point the firm will create a provision for doubtful debts accounts. The accounting entry for the
creation of a provision for doubtful debts is:
Debit
Income statement/profit and loss
Credit
Provision for doubtful debts account
At the end of the accounting period the Provision for Doubtful Debts would have served two purposes:
1. Reduce the profit for the period by providing for estimated loss
2. Reduce the asset of debtors on the balance sheet, since the provision is deducted from debtors in
the balance sheet.
In this way the account will have a true and fair representation of the profit expected and the amount the
business reasonably expects to collect from debtors.
Example:
The accounts receivable of a business total $28 600 as at March 31 2009 and it has decided to create a
provision for doubtful debts at 5%.
Date
Details
2009
Mar
31
Provision for Doubtful Debts

Amou
Date
Details
nt
Bal. c/d
$
1 430
2009
Mar 31 Profit and Loss
Amount
$
1 430
Apr 1
Bal. b/d
1 430
The balance brought down on the provision for doubtful debts is deducted from the debtors figure in the
Balance Sheet.
Balance Sheet (Extract)
Current Assets:
Debtors
28 600
Less provision for doubtful debts
(1 430)
27 170
Maintaining the Provision for Doubtful Debts

Once a provision for doubtful debts has been established, it remains on the books and appears in the
Balance Sheet. In subsequent accounting periods the amount to be treated as doubtful debt will vary:
1. When the provision is to be increased:
Debit
Credit
profit and loss

provision for doubtful account (with the amount needed to increase
the provision)
2. When the provision is to be decreased:

Debit
Credit
provision for doubtful account

profit and loss account (with the amount needed to decreased the
provision)
Example:
Singhs Flower Shop has provided you with the following information relating to the firms debtors.
Year
Debtors Balance
Bad Debts Write
Provision for Bad
Off
Debts
Year 1 (2010)
18 900
450
369
Year 2 (2011)
36 000
720
1 764
Year 3 (2012)
27 760
555
816
Provision for Bad Debts A/c
Date
Details
Amou
Date
2010
nt
2010
Dec
$
369
Bal. c/d
31
2011
Details
Amount
$
Dec 31 Profit and loss
369
2011
Dec
Bal. c/d
1 764
Jan 01
Bal. b/d
369
31
Dec 31 Profit and Loss
1 764
2012
Dec
1 395
1 764
2012
Profit and Loss
948
Jan 01
Bal. c/d
816
1 764
Dec 31
Bal. b/d
1 764
31
1 764
2013
Jan 01
Bal. b/d
816
Effect on the Income Statement/Trading and Profit and Loss

Both bad debts and increases in provision for bad debts are subtracted from gross profit in the profit and
loss account. Decreases in the provision for debts are treated as additions to the gross profit in the profit
and loss account.
Income Statement (extract) for 2010
Gross profit
18 000
Bad debts
450
Provision for doubtful debts
369
Other expenses
1 000
Net profit
(1 819)
16 181

Gross profit
12 000
Bad debts
720
Increase in provision for bad debts
1 395
Other expenses
1 000
(3 115)
8 885

Gross profit
16 450
Add reduction in provision for doubtful debts
948
17 398
Bad debts
555
Other expense
1 000
Net profit
15 843
Effect on the Balance Sheet

Balance Sheet (extract) 2010
Current Assets:
Debtors
18 450
Less provision for bad debts
(369)
18 081

Current Assets:
Debtors
35 280
(1 764)
33 516

Current Assets:
(1 555)
Debtors
27 205
(816)
26 389
When a trial balance is drawn up any bad debts already written off will appear in the debit column. If a
provision for doubtful debt has been created before, the opening balance will appear on the credit side.
Bad Debts Recovered

In some instances, payment is received after a debt has been written off as bad. This is probably due to
change in fortune of the debtor. The payment is credited to a bad debt recovered account and NOT to
the personal account of the debtor since the account was closed off some time in the past. The recovered
debt is transferred to the debit side of the Profit and Loss Account.
Example:
E. Cain, a former debtor, has sent a cheque for $575 as payment for a debt, which was written off as bad
some time ago.
Date
Details
Bank
Debit
Credit
575
Bad debt recovered
575
Payment received for a debt previously written of as bad

Bad debts recovered
Profit and loss
Bad debts recovered transferred to the Profit and Loss Account
575
575

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Bad Debts and Provision for Bad Debts

Bad Debts A/c

Bad debts A/c

Bad Debts A/c

Income statement/profit and loss

Provision for doubtful debts account

Provision for Doubtful Debts

Less provision for doubtful debts

Maintaining the Provision for Doubtful Debts

profit and loss

2. When the provision is to be decreased:

provision for doubtful account

Bad Debts Write

Provision for Bad

Provision for Bad Debts A/c

Dec 31 Profit and loss

Effect on the Income Statement/Trading and Profit and Loss

Provision for doubtful debts

Income Statement (extract) for 2011

Increase in provision for bad debts

Income Statement (extract) for 2012

Add reduction in provision for doubtful debts

Effect on the Balance Sheet

Less provision for bad debts

Balance Sheet (extract) 2011

Less provision for bad debts

Balance Sheet (extract) 2012

Less provision for bad debts

Bad Debts Recovered

Payment received for a debt previously written of as bad

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