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TOPIC 6: BAD DEBTS | B/KEEPING FORM 3

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The Bad Depts Account
Show the bad debts account
What are bad debts?
The term bad debts
usually refers to accounts receivable (or trade accounts receivable)
that will not be collected. However, bad debts can also refer to notes
receivable that will not be collected.
The
bad debts associated with accounts receivable is reported on the income
statement as Bad Debts Expense or Uncollectible Accounts Expense.
When
the allowance method is used, the journal entry to Bad Debts Expense
will include a credit to Allowance for Doubtful Accounts, a contra
account and valuation account to the asset Accounts Receivable. The
allowance method anticipates the losses and therefore requires the use
of estimates.
Under
the direct write-off method, the Allowance for Doubtful Accounts is not
used. Rather, Bad Debts Expense will be debited when an account
receivable is actually written off. The credit in this entry will be to
the asset Accounts Receivable.
Accounting entry required to write off a bad debt is as follows:
Debit Bad Debt Expense
Credit Receivable
The
credit entry reduces the receivable balance to nil as no amount is
expected to be recovered from the receivable. The debit entry has the
effect of cancelling the impact on profit of the sales that were
previously recognized in the income statement.
Example 1
Example
ABC
LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently
finds out that DEF LTD is being liquidated and therefore the prospects
of recovering its dues are very low.
ABC LTD should write off the receivable from DEF LTD in view of the circumstances. The double entry will be recorded as follows:
$ $
Debit Bad Debt Expense 500
Credit DEF LTD (Receivable) 500
Bad Debt Recovered
Occasionally,
a bad debt previously written off may subsequently settle its debt in
full or in part. In such case, it will be necessary to cancel the effect
of bad debt expense previously recognized up to the amount settlement.
Example 2
Example
ABC
LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently
finds out that DEF LTD is being liquidated and therefore the prospects
of recovering its dues are very low. ABC LTD therefore writes off the
receivable from its books. However, the administrator appointed to
oversee the liquidation of DEF LTD instructs the company to pay $300 to
ABC LTD in full settlement of its dues.
As
$300 of the bad debt has been recovered, it is necessary to cancel the
effect of previously recognized bad debt expense up to this amount. The
accounting entry will therefore be as follows:
$ $
Debit Cash 300
Credit Bad Debt Recovered (Income) 300
– See more at: http://accounting-simplified.com/accounting-for-bad-debts.html#sthash.6wuDrJGR.dpuf
Provision for Bad Debts Account
The provision for bad debts account
The
provision for doubtful debts is the estimated amount ofbad debtthat
will arise from accounts receivable that have been issued but not yet
collected. Itis identical to the allowance for doubtful accounts. The
provision is used under accrual basis accounting, so that an expense is
recognized for probable bad debts as soon as invoices are issued to
customers, rather than waiting several months to find out exactly which
invoices turned out to be uncollectible. Thus, the net impact of the
provision for doubtful debts is to accelerate the recognition of bad
debts into earlier reporting periods.
A
business typically estimates the amount of bad debt based on historical
experience, and charges this amount to expense with a debit to the bad
debt expense account (which appears in the income statement) and a
credit to the provision for doubtful debts account (which appears in the
balance sheet). The organization should make this entry in the same
period when it bills a customer, so that revenues are matched with all
applicable expenses (as per the matching principle).
The
provision for doubtful debts is an accounts receivable contra account,
so it should always have a credit balance, and is listed in the balance
sheet directly below the accounts receivable line item. The two line
items can be combined for reporting purposes to arrive at a net
receivables figure.
Later,
when you identify a specific customer invoice that is not going to be
paid, eliminate it against the provision for doubtful debts. This can be
done with a journal entry that debits the provision for doubtful debts
and credits the accounts receivable account; this merely nets out two
accounts within the balance sheet, and has no impact on the income
statement. If you are using accounting software, create a credit memo in
the amount of the unpaid invoice, which creates the same journal entry
for you.
It
is highly unlikely that the provision for doubtful debts will always
exactly match the amount of invoices that are actually unpaid, since it
is only an estimate. Thus, you will need to adjust the balance in this
account over time to bring it into closer alignment with the ongoing
best estimate of bad debts. This can involve an additional charge to the
bad debt expense account (if the provision appears to initially be too
low) or a reduction in the expense (if the provision appears to be too
high).
Example 3
Example
ABC
LTD has trade receivable of worth $50,000 as at 31 December 2010. XYZ
LTD, a receivable owing $10,000 to ABC LTD at the year end, has been
recently been wound up. Consequently, ABC LTD does not expect to recover
the amount due from XYZ LTD. Based on past experience, ABC LTD
estimates that 5% of its receivables will default. Allowance for
doubtful debts on 31 December 2009 was $1500.
ABC
LTD must write off the $10,000 receivable from XYZ LTD as bad debt.
Accounting entry to record the bad debt will be as follows:
$ $
Debit Bad Debt Expense 10,000
Credit XYZ LTD (Receivable) 10,000
A
general allowance of $2,000 [( 50,000-10,000) x 5%] must be made. As a
general allowance of $1500 has already been created, only $500
additional allowance must be charged to the income statement:
$ $
Debit Allowance for Doubtful Debts (Expense) 500
Credit Allowance for Doubtful Debts (Balance Sheet) 500
Note
that $10,000 in respect of receivable from XYZ LTD has been excluded
from the calculation of the general allowance as it has already been
written off in full:
Bad Debt Expense
Debit $ Credit $
XYZ LTD (Receivable) 10,000 Income Statement 10,000
10,000 10,000
XYZ LTD Receivable
Debit $ Credit $
Sales 10,000 Bad Debt Expense 10,000
10,000 10,000
Allowance for Doubtful Debts
Debit $ Credit $
Balance c/d 2,000 Balance b/d 1,500
Income Statement 500
2,000 2,000
Preparation of a Computation of the Amount to be Shown as Trade Debtors in the Company Balance Sheet
Prepare a computation of the amount to be shown as Trade debtors in the company balance sheet
The bad debts after trial balance, provision for doubtful debts and provision for discount on debtors will appear in the balance sheet as
Debtors xxxx
Minus: Bad debts xxxx
Minus: Provision for doubtful debts xxxx
Minus: Provision for discount on debtors xxxx
Preparation of a Provision for Discounts on Debtors
Prepare a provision for discounts on debtors
Provision for discount on debtors
In
business world a lot of sales transactions happen on credit, i.e. after
a specified period of time. In this scenario, there are two main types
of discounts allowed to customers. One is trade discount and the other is acash discount.
Now,
after anticipating the amount of cash discount allowable to debtors, a
separate “provision for discount on debtors account” is opened and it is
very similar to the “provision for doubtful debts account”. The only
difference between the two is that provision for discount is calculated
on the debtors’ balance after deducting the provision for doubtful
debts.
Journal Entry for Creating a Provision on Discount on Debtors
Profit & Loss A/C Debit
To Provision for Discount on Debtors A/C Credit
  • If
    a provision for discount on debtors exists at the time of providing
    discount, then write off the discount from that provision.
  • A new
    provision should then be calculated to the extent of bringing the
    existing provision to thenew figure. Ajournal entry would include
    debiting P&L account and crediting provision for discount on
    debtors.
  • If new provision required is lower than the provision
    already existent, then we need to transfer the difference to P&L
    account. In this case, the journal entry would be reverse of what is
    mentioned in the previous point.

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