Bad Debts / Irrecoverable Debts
An entity may not be able to recover its balances outstanding in respect of certain receivables. In accountancy we refer to such receivables as Irrecoverable Debts or Bad Debts. Bad debts could arise for a number of reasons such as customer going bankrupt, trade dispute or fraud.
Every time an entity realizes that it unlikely to recover its debt from a receivable, it must 'write off' the bad debt from its books. This ensures that the entity's assets (i.e. receivables) are not stated above the amount it can reasonably expect to recover which is in line with the concept of prudence.
Accounting entry required to write off a bad debt is as follows:
|Debit||Bad Debt Expense|
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.
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.
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:
|Credit||Bad Debt Recovered (Income)||$300|