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OLevel

Accounting - 7707

Bad Debts and Provision for Doubtful Debts

Paper-2

Bad Debts and Provision for Doubtful Debts
When the receivable fail to pay back the amount due to them, they are referred to as bad debts. Bad debt is an actual loss of the business and is recorded in the books of account as per the matching concept. Double entries to record bad debts are 

Bad Debt DR→ Expense 
Receivables CR →Asset 

Why Does a Receivable Become Bad Debt?

Receivables become a Bad Debt because 

1. Receivable has become bankrupt/insolvent/liabilities of receivable are greater than his assets. 

2. Receivable dies.

3. Receivable becomes mentally retarded.

4. Receivable runs away.

5. Receivable refuses to pay.

If the business expects that some of its customers will fail to pay back the amount that they owe, then the business will create a provision for Bad Debts or a provision for doubtful debts. Provision for doubtful debts are the expected losses of the business, and as per the prudence concept, expected losses are to be treated as expenses. Moreover, like all provisions, provision for doubtful debts is Contra Assets. Hence, the double entries to record provision for doubtful debts are 

I/S DR → Expense as per prudence concept
Provision for Bad Debts CR→Contra Asset

Doubtful Debts


Specific Provision
General Provision

Provision for the doubtful debt if given as a percentage is always changed on the net debt figure, i.e., receivables minus bad debts. Moreover, if there are any specific provisions, their general provision will be changed on the net debt figure after a specific provision has been deducted from it.

Receivables
(Bad Debts)

Net Debts                      → Provision for bad debts will be charged on this figure if there are no specific provisions.
(Specific Provisions)


How is the Rate of General Provision Provided?


1. Experience 
2. Economic Conditions 
3. Age of Debt
4. Creditworthiness of Receivables
5. Industry Averages

Provision for Discount Allowed:

If the business expects that some of its customers will pay back their outstanding dues on time to avail discounts, then they need to create provisions for discount allowed. Provision for discount allowed like all provisions is Contra Asset as well as expected loss, and hence accounting treatment of provision for discount allowed is exactly same as provision for doubtful debts, and hence double entries to record a provision for discount allowed is
                   
I/S DR → Expense
Provision for discount all CR→ Contra Asset

Provision for discount allowed is also charged on the net debt figure after a specific provision has been deducted from it.

Bad Debts Recovered: 

If the receivable which has been declared bad debt a few years ago certainly comes back and pays back full or part of the amount, he owed then he will be treated as bad debts recovered, which is an income for the business. Hence, double entries to record bad debts recovered are:


Receivable                                          DR 
                                                 Bad debts recovered             CR 

Bank                                                      DR 
                                                         Receivable                         CR 

Bad debts recovered                     DR 
                                                   Income Statement               CR


Q:  At the end of 2015, the receivables of business amounted to $12000, of which receivables worth $2000 prove to be bad. The business policy is to charge provision for the bad debt at the rate of 5% of the net debt figure. At the end of 2016, receivables amounted to $15000, of which $1000 proved to be bad. At the end of 2017, receivables amounted to $9500, of which $1500 prove to be bad.

You are required to prepare the following accounts showing all works clearly:

1. Bad Debt Accounts
2. Provision for Bad Debt Accounts 
3. I/S Extract

SOLUTION:







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