Financial AccountingBad Debt Expense

One risk of running a business among others, is that few of the debtors may never pay back the money receivable from them. There are many reasons due to which the debtors may not be able to pay for the goods/ services sold on credit to them and may results into nonpayment by the customer, few example of such reason are given below;

• The customer has gone bankrupt or has filed for bankruptcy in court of law.
• Due to financial difficulties the customer may not be able to pay full amount due and has agreed to pay partially.
• Debtor has been refusing to pay in full for some invoices,  due to the provision of unsatisfactory goods/ service or quality concern.

In practice, as soon as it becomes certain that the debtor will not be able to pay and there are no chances of recovery, the receivable amount shall be written off and the debtor account shall be closed in the books of account.

Following are the examples of circumstances in which the debtor may be declared as bad debt and shall be written off.

• The Debtor has filed bankruptcy and became insolvent.
• The debtor can’t be traced for a long time.
• The amount is immaterial and it is not economical to trace the debtor for recovery.
• All the possible efforts have been made to recover the amount receivable including filing a suit but recovery could not be made. 

Accounting Entries to Record Bad Debts. 

Dr. Bad Debt Expense XXX

Cr. Debtor XXX

When it is certain that the debtor had become BAD, and not recoverable, the debtor needs to be removed from the book of accounts and an expense of equal amount is recorded and charged to the profit and loss for the period.

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Example

The XYZ Co. sold the goods worth of $ 500 on credit to Mr. Chips in the Month of August 2X20 with the credit term of 30 days. The debtor was not paying despite sending several reminders and notices. At the year end i.e. June, 2X21 it was revealed that, Mr. Chips has filed a bankruptcy in the court and does not have enough financial resources to pay back its debts. The management decided to write off the debtor in its books of accounts.

The Accounting entry for this transaction will be as follows:

Dr. Bad debt Expense $500

Cr. Mr. Chips (debtor Account) $500

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Bad debt recovered

There may be instances, when the debtors/ customers which had previously been written off, pay back the receivable amount. There can be several reasons for customers, who once were unwilling/ unable to pay are now want to payback the amounts payable by them;

• The owner of the business, once facing financial difficulties, has now obtained fresh finances to run the business. 
• The Business previously was making losses and was unable to pay its debts have now become profitable.
• Business was closed due to any reason, has now been resumed and want to carry out the business activities.
• The business had filed a recovery suit against the debtor, which was decided in the favor of the business and the debtor was asked by the court of law to pay back the business.

Accounting Entries for Bad debt recovered.

1. When recovery of bad debt have become certain/ debtor have agreed to pay back the amount receivable;

Dr. Debtor XXX

Cr. Bad debt recovered (Income) XXX

2. When the cash from debtor have been received;

Dr. Cash/ Bank XXX

Cr. Debtor XXX

If the the receivables from a debtor previously written off, have subsequently been recovered the debtor shall be reinstated by the amount receivable from the debtor and a gain by the name of Bad Debt Recovered shall be recorded. Finally upon the receipt of cash from the debtor the debtor account is credited and cash/ bank book is debited.

Considering the example of Mr. Chips above, assume that Next Mr. Chips was able to obtain further financing and approached XYZ Co. to purchase some goods and he was denied because of the previous default. Mr. Chips committed to pay back the earlier receivable of    $ 500 inorder to restore business relationship with the company.

The Accounting Entries for the above transaction will be as follows,

Dr. Mr. Chips (Debtor) $ 500

Cr. Bad debt recovered (Income) $500

2. When the cash from debtor have been received;

Dr. Cash/ Bank $500

Cr. Mr. Chips (Debtor) $500

The above transaction will result in reinstating the debtor account of Mr. Chips with all the debts being paid off by the debtor (Mr. Chips)

At the end of the accounting period, the total balance of the Bad Debt recovered account is either transferred to the Bad debt expense account or directly charged to the Profit and Loss account as gain/ income for the period.

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