Definition of bad debts:
A bad debt is money owed to you that you can't collect. If someone owes you money that you cannot collect, you may have a bad debt. A debt that is not collectible and
therefore worthless to the creditor. This occurs after all attempts are made to collect on the debt. Bad debt is usually a product of the debtor going into bankruptcy or
where the additional cost of pursuing the debt is more than the amount the creditor could collect. This debt, once considered to be bad, will be written off by the
company as an expense.
Bad debts occur when you provide products or services on credit. While some customers just need more time to pay, others (hopefully a small number!) never will, and
the income from the sale is never realized.
Accounts receivable that will likely remain uncollectable and will be written off. Bad debts appear as an expense on the company's income statement, thus reducing net
income. In general, companies make an estimate of bad debt expenses that might be incurred in the current time period based on past records as part of the process of
estimating earnings. Most companies make a bad debt allowance since it is unlikely that all of their debtors will pay them in full.
Most companies make sales on credit as it generally allows them to increase their sales, even though some sales are to customers with less than desirable credit.
Companies that do make credit sales will estimate the amount of sales they expect to lose to bad debt, which is found in the allowance for doubtful accounts.
A debtor with a history of bad debts will see their credit rating decline, which makes it difficult for the debtor to access any additional form of credit.
Example: if you have a credit card, a home loan, a car loan or a personal loan and you are behind on it, you have created bad debt.
The debt is immediately written off by crediting the debtor's account, eliminating any balance remaining there. The crediting represents a loss to the creditor.
Definition of doubtful debt:
Doubtful debts are those debts which a business or individual is unlikely to be able to collect. The reasons for potential non payment can include disputes over supply,
delivery, at the conditioner of item or the appearance of financial stress within a customer's operations.
When such a dispute occurs it is prudent to add this debt or portion thereof to the doubtful debt reserve. This is done to avoid over-stating the assets of the business as
trade debtors is reported net of Doubtful debt. When there is no longer any doubt that a debt is uncollectible the debt becomes bad.
Definition of provisions for doubtful debts:
The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for
Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account
Accounts Receivable in order to report the net realizable value of the accounts receivable.
Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the
Provision for Bad Debts reports the credit losses that pertain to the period shown on the income statement.
Difference between bad debts and provisions for doubtful debts
A bad debt is one that is not collectible and therefore worthless to the creditor. This occurs after all attempts are made to collect on the debt. Bad debt is usually a
product of the debtor going into bankruptcy or where the additional cost of pursuing the debt is more than the amount the creditor could collect. This debt, once
considered to be bad, will be written off by the company as an expense.
For example, Joe Shmo, who owed you R1,000, files bankruptcy and informs you of this. So it seems we won't get paid by Joe in future.
The original journal entry to record the sale would have been:
Dr Debtors Control R1,000
Cr Sales R1,000
When we become aware that the debt has become 'bad', we do an entry as follows:
Dr Bad debt (expense) R1,000
Cr Debtors Control R1,000
The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for
Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account
Accounts Receivable in order to report the net realizable value of the accounts receivable.
Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the
Provision for Bad Debts reports the credit losses that pertain to the period shown on the income statement. For example, let's say that at the end of the year we have
R200,000 in debtors control. We expect 2% of debts owed to us to go bad in future. This amounts to R4,000 of our current debts.
The entry to record this provision for bad debts is:
Dr Bad debts (expense) R4,000
Cr Provision for Bad Debts (like a liability) R4,000
If nothing changes (we continue to expect 2% of all debts to go bad) then we keep our provision - our estimate - of bad debts, for as long as the business is running.
In the meantime, if some actual debts go bad (like the first example above), then we record an additional bad debt expense (as above).
The provision for bad debts is kept as a separate account to the debtors control.
These two accounts are, however, set off against one another in the balance sheet in order to present the true value of debtors.
Bad Debts -
, i. To write of bad debts - debit Bad Debts Account, and credit Debtor Account.
ii. To transfer bad debts for the year to the Profit and Loss Account - credit Bad Debts Account, and debit Profit and Loss Account.
Recovery of Bad Debts -
i. To bring into books recovery of bad debts - debit Cash Book, and credit Recovery of Bad Debts Account.
ii. To transfer recovery of bad debts for the year to the Profit and Loss Account - debit Recovery of Bad Debts Account, and credit Profit and Loss
Account.
Provision for Bad and Doubtful Debts -
i. To create the provision - debit Profit and Loss Account, and credit the Provision Account (with the amount of provision for the year).
ii. To increase the provision - debit Profit and Loss Account, and credit the Provision Account (with the amount of increase in the provision for the
year).
iii. To decrease the provision - debit the Provision Account, and credit Profit and Loss Account (with the amount of decrease in the provision for the
year).
iv. How details are shown in Balance Sheet –
Why we need them?
Provision for Bad or Doubtful Debts are made because of the need to -
i. match expenses in the same year that the revenue is recognized (matching principle);
ii. show a more conservative and true figure for the net asset 'Debtors' in the Balance Sheet (principle of conservatism).
Doubtful debt reserve
Also known as a bad debt reserve, this is a contra account listed within the current asset section of the balance sheet. The doubtful debt reserve holds a sum of money to
allow a reduction in the accounts receivable ledger due to non-collection of debts. This can also be referred to as an allowance for bad debts. Once a doubtful debt
becomes uncollectable, the amount will be written off.
Allowance for bad debts are amounts expected to be uncollected, but still with possibilities of being collected (when there is no other possibility for them to be
collected, they are considered as uncollectible accounts).
For example, if gross receivables are $100,000 and the amount that is
expected to remain uncollected is $5,000, net current asset section of balance sheet will be:
Gross accounts receivable
$100,000
Less: Allowance for bad debts
$5,000
Net receivables
$95,000
A bad debt is money owed to you that you can't collect. If someone owes you money that you cannot collect, you may have a bad debt. A debt that is not collectible and
therefore worthless to the creditor. This occurs after all attempts are made to collect on the debt. Bad debt is usually a product of the debtor going into bankruptcy or
where the additional cost of pursuing the debt is more than the amount the creditor could collect. This debt, once considered to be bad, will be written off by the
company as an expense.
Bad debts occur when you provide products or services on credit. While some customers just need more time to pay, others (hopefully a small number!) never will, and
the income from the sale is never realized.
Accounts receivable that will likely remain uncollectable and will be written off. Bad debts appear as an expense on the company's income statement, thus reducing net
income. In general, companies make an estimate of bad debt expenses that might be incurred in the current time period based on past records as part of the process of
estimating earnings. Most companies make a bad debt allowance since it is unlikely that all of their debtors will pay them in full.
Most companies make sales on credit as it generally allows them to increase their sales, even though some sales are to customers with less than desirable credit.
Companies that do make credit sales will estimate the amount of sales they expect to lose to bad debt, which is found in the allowance for doubtful accounts.
A debtor with a history of bad debts will see their credit rating decline, which makes it difficult for the debtor to access any additional form of credit.
Example: if you have a credit card, a home loan, a car loan or a personal loan and you are behind on it, you have created bad debt.
The debt is immediately written off by crediting the debtor's account, eliminating any balance remaining there. The crediting represents a loss to the creditor.
Definition of doubtful debt:
Doubtful debts are those debts which a business or individual is unlikely to be able to collect. The reasons for potential non payment can include disputes over supply,
delivery, at the conditioner of item or the appearance of financial stress within a customer's operations.
When such a dispute occurs it is prudent to add this debt or portion thereof to the doubtful debt reserve. This is done to avoid over-stating the assets of the business as
trade debtors is reported net of Doubtful debt. When there is no longer any doubt that a debt is uncollectible the debt becomes bad.
Definition of provisions for doubtful debts:
The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for
Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account
Accounts Receivable in order to report the net realizable value of the accounts receivable.
Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the
Provision for Bad Debts reports the credit losses that pertain to the period shown on the income statement.
Difference between bad debts and provisions for doubtful debts
A bad debt is one that is not collectible and therefore worthless to the creditor. This occurs after all attempts are made to collect on the debt. Bad debt is usually a
product of the debtor going into bankruptcy or where the additional cost of pursuing the debt is more than the amount the creditor could collect. This debt, once
considered to be bad, will be written off by the company as an expense.
For example, Joe Shmo, who owed you R1,000, files bankruptcy and informs you of this. So it seems we won't get paid by Joe in future.
The original journal entry to record the sale would have been:
Dr Debtors Control R1,000
Cr Sales R1,000
When we become aware that the debt has become 'bad', we do an entry as follows:
Dr Bad debt (expense) R1,000
Cr Debtors Control R1,000
The provision for bad debts might refer to the balance sheet account also known as the Allowance for Bad Debts, Allowance for Doubtful Accounts, or Allowance for
Uncollectible Accounts. In this case Provision for Bad Debts is a contra asset account (an asset account with a credit balance). It is used along with the account
Accounts Receivable in order to report the net realizable value of the accounts receivable.
Provision for Bad Debts might also be an the income statement account also known as Bad Debt Expense or Uncollectible Account Expense. In this situation, the
Provision for Bad Debts reports the credit losses that pertain to the period shown on the income statement. For example, let's say that at the end of the year we have
R200,000 in debtors control. We expect 2% of debts owed to us to go bad in future. This amounts to R4,000 of our current debts.
The entry to record this provision for bad debts is:
Dr Bad debts (expense) R4,000
Cr Provision for Bad Debts (like a liability) R4,000
If nothing changes (we continue to expect 2% of all debts to go bad) then we keep our provision - our estimate - of bad debts, for as long as the business is running.
In the meantime, if some actual debts go bad (like the first example above), then we record an additional bad debt expense (as above).
The provision for bad debts is kept as a separate account to the debtors control.
These two accounts are, however, set off against one another in the balance sheet in order to present the true value of debtors.
Bad Debts -
, i. To write of bad debts - debit Bad Debts Account, and credit Debtor Account.
ii. To transfer bad debts for the year to the Profit and Loss Account - credit Bad Debts Account, and debit Profit and Loss Account.
Recovery of Bad Debts -
i. To bring into books recovery of bad debts - debit Cash Book, and credit Recovery of Bad Debts Account.
ii. To transfer recovery of bad debts for the year to the Profit and Loss Account - debit Recovery of Bad Debts Account, and credit Profit and Loss
Account.
Provision for Bad and Doubtful Debts -
i. To create the provision - debit Profit and Loss Account, and credit the Provision Account (with the amount of provision for the year).
ii. To increase the provision - debit Profit and Loss Account, and credit the Provision Account (with the amount of increase in the provision for the
year).
iii. To decrease the provision - debit the Provision Account, and credit Profit and Loss Account (with the amount of decrease in the provision for the
year).
iv. How details are shown in Balance Sheet –
Why we need them?
Provision for Bad or Doubtful Debts are made because of the need to -
i. match expenses in the same year that the revenue is recognized (matching principle);
ii. show a more conservative and true figure for the net asset 'Debtors' in the Balance Sheet (principle of conservatism).
Doubtful debt reserve
Also known as a bad debt reserve, this is a contra account listed within the current asset section of the balance sheet. The doubtful debt reserve holds a sum of money to
allow a reduction in the accounts receivable ledger due to non-collection of debts. This can also be referred to as an allowance for bad debts. Once a doubtful debt
becomes uncollectable, the amount will be written off.
Allowance for bad debts are amounts expected to be uncollected, but still with possibilities of being collected (when there is no other possibility for them to be
collected, they are considered as uncollectible accounts).
For example, if gross receivables are $100,000 and the amount that is
expected to remain uncollected is $5,000, net current asset section of balance sheet will be:
Gross accounts receivable
$100,000
Less: Allowance for bad debts
$5,000
Net receivables
$95,000
