Bad debts and Provision for Bad debts Bad

Bad debts and Provision for Bad debts

Bad Debts When the firm finds that it is impossible to collect a debt, that debt should be written off as a bad debt. Accounting Entries: Dr Bad Debts Cr Debtor With the irrecoverable amount of a debt

Example During the year, a company sold goods for $2, 000 to Mr. Lee, $1, 500 to Mr. Wong and $300 to Mr. Wu. Mr. Lee and Mr. Wong paid the company $800 and $1, 000 respectively Later, Mr. Wong and Mr. Wu became bankrupt, and it is impossible for the company to collect these debts. The company decided to write these off as bad debts.

Mr. Lee Sales $ 2, 000 Bank Balance c/f 2, 000 $ 800 1, 200 2, 000 Mr. Wong Sales $ 1, 500 Bank Bad Debts 1, 500 $ 1, 000 500 1, 500 Mr. Wu Sales $ 300 Bad Debts $ $ Mr. Wong Mr. Wu 500 300 800 P/L 800

B. Provision for Bad / Doubtful Debts A provision for bad and doubtful debts may be made when a firm thinks that there will be problems in recovering a debt.

Accounting entries Increase in provision Dr Profit and Loss Cr Provision for Bad Debts Decrease in provision Dr Provision for Bad Debts Cr Profit and Loss With the increase in the amount of provision for bad debts With the decrease in the amount of provision for bad debts

Increase in provision for bad debts Example A firm decided to make a provision for bad debts at 10% of the debtors’ accounts which totalled $50, 000 on 31 December 1994. On 31 December 1995, the debtors accounts totalled $60, 000. The firm maintained the provision at 10% of its total debtors.

Provision for Bad Debts 1994 $ Dec 31 Balance c/d 1994 5, 000 Dec 31 Profit and loss $ 5, 000 ($50, 000 * 10%) Profit and Loss Account for the year ended 31 December (Extract) 1994 $ $ X Gross profit Less: Expenses Increase in provision for bad debt 5, 000 Balance Sheet as at 31 December (Extract) 1994 Current Assets 50, 000 Debtors Less: provision for bad debt 5, 000 45, 000

Provision for Bad Debts 1994 $ Dec 31 Balance c/d 1994 5, 000 $ Dec 31 Profit and loss 5, 000 ($50, 000 * 10%) 1995 Jan 1 Dec 31 Balance c/f ($60, 000*10%) 6, 000 Balance b/d Dec 31 Profit and Loss 5, 000 1, 000 6, 000 Profit and Loss Account for the year ended 31 December (Extract) Gross profit 1994 $ $ X Less: Expenses Increase in provision for bad debt 5, 000 1995 $ $ X 1, 000

Balance Sheet as at 31 December (Extract) 1994 Current Assets 50, 000 Debtors Less: provision for bad debt 5, 000 45, 000 1995 60, 000 6, 000 54, 000

Decrease in Provision for bad debts Example The debtors’ accounts on 31 December 1996 totalled $40, 000. The firm decided to maintain the provision at 10% of the total debtors.

Provision for Bad Debts 1994 $ Dec 31 Balance c/d 1994 5, 000 $ Dec 31 Profit and loss 5, 000 ($50, 000 * 10%) 1995 Jan 1 Dec 31 Balance c/f ($60, 000*10%) 6, 000 Balance b/d Dec 31 Profit and Loss $ Dec 31 Profit and Loss 31 Balance c/f 32 ($40, 000*10%) 1, 000 6, 000 1996 5, 000 1996 2, 000 Jan 1 Bal b/f $ 6, 000 4, 000 6, 000

Profit and Loss Account for the year ended 31 December (Extract) 1994 $ $ Gross profit X Add: Decrease in provision for bad debts Less: Expenses Increase in provision for bad debt 5, 000 1995 $ $ X 1996 $ 1, 000 Balance Sheet as at 31 December (Extract) 1994 Current Assets 50, 000 Debtors Less: provision for bad debt 5, 000 45, 000 1995 1996 60, 000 6, 000 54, 000 40, 000 4, 000 36, 000 $ X 2, 000

C. Bad Debts Recovered Bad debts recovered refers to debts formerly written off to be recovered later.

Accounting entries Dr Debtors Cr Bad Debts Recovered With the debt reinstated in the debtor’s account Dr Cash/Bank Cr Debtors With the amount received Dr Bad Debts Recovered Cr Bad Debts OR Dr Bad Debts Recovered Cr Profit and Loss With the debt written off in this year to be recovered OR With the debt written off in a previous year to be recovered

Example The following balances were part of the trial balance of Mr. Chan on 31 December 1996: Debtors Bad Debts $ 10, 000 1, 000 During the year, Mr. Chan received $300 and $1, 200 from debtors, whose debts had been previously written off as bad debts in the current year and last year respectively. No entry has been made for these transactions

1996 Dec 31 Debtors 1996 Dec 31 Bal b/d Dec 31 B. D. R. 1996 Dec 31 Bal b/d 1996 Dec 31 Bad Debt Dec 31 P & L Bank $ 1, 500 Debtors $ 1996 $ 10, 000 Dec 31 Bank 300 1, 200 Bad Debt 1, 500 $ 1996 1, 000 Dec 31 B. D. R. Dec 31 P & L 1, 000 Bad Debt Recovered $ 300 1, 200 1, 500 1996 Dec 31 Debtors $ 300 700 1, 000 $ 300 1, 200 1, 500

Profit and Loss Account for the year ended 31 December (Extract) 1996 Gross profit Add: Bad Debt Recovered $ Less: Expenses Bad Debt 700 $ X 1, 200