Bad debts and Provisions

There are two ways to record a bad debt, which are:

Direct write-off method. If you only reduce accounts receivable when there is a specific, recognizable bad debt, then debit the Bad Debt Expense for the amount of the write-off, and credit the accounts receivable asset account for the same amount.

Example: The policy of the company is that if a debtor will not pay his or her debts even after the end of the financial year, such a debt will be counted as a bad debt. The transaction for the year ended 2021 was as follows:

08.01: Goods sold on credit to Goodluck Tshs 100,000

16.01 Goods sold on credit to Felister Tshs 480,000

17.08 Felister paid us Tshs 400,000 in respect of goods sold to her.

Required

For the year ended 2021 prepare the following:

i. Goodluck account

ii. Felister account

iii. Bad debts account

iv. Profit and loss account

Date	Details	Amount	Date	Details	Amount
DR	GOODLUCK ACCOUNT				CR
2021 08.01	Sales	100,000	2021 31.12	Bad debts	100,000
		100,000			100,000

Date	Details	Amount	Date	Details	Amount
DR	FELISTER ACCOUNT				CR
2021 16.02	Sales	480,000	2021 17.08	Cash	400,000
			2021 31.12	Bad debts	80,000
		480,000			480,000

Date	Details	Amount	Date	Details	Amount
DR	BAD DEBT ACCOUNT				CR
2021 31.12	Goodluck	100,000	2021 31.12	Profit and loss	180,000
2021 31.12	Felister	80,000
		180,000			180,000

Date	Details	Amount	Date	Details	Amount
DR	PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 31.12.2021				CR
	Bad Debts	180,000

The direct write-off method is not the best approach, because the charge to expense may occur several months after you recorded the related revenue, so there is no matching of revenue and expense within the same period (the matching principle).

If you charge an estimated amount of accounts receivable to bad debt expense in the same period when you record related revenue, then debit the Bad Debt Expense for the amount of the estimated write-off, and credit the Allowance for Doubtful Accounts contra account for the same amount.

The accounting entries needed for the allowance for doubtful debts are:

Year in which the allowance is first made:

• Debit the profit and loss account with the amount of the allowance (i.e, deduct it from gross profit as an expense)
• Credit the allowance for Doubtful Debts Account

Bad debt recovery is a payment received for a debt that was written off and considered uncollectible. The receivable may come in the form of a loan, credit line, or any other accounts receivable.

Because it generally generates a loss when it is written off, bad debt recovery usually produces income. In accounting, the bad debt recovery credits the allowance for bad debts or bad debt reserve categories and reduces the accounts receivable category in the books.

When bad debts written from in previous years are recovered the bookkeeping procedures are as follows:

i. Reinstate the deb by making the following entries

Dr Debtor's account

Cr Bad debts recovered account

ii. When payment is received from the debtor in settlement of all or part of the debt:

Dr Cash/Bank

Cr Debtor's account

iii. To recognize an income, the double entries are:

Dr Bad debts recovered account

Cr Profit and loss account

Some companies create provisions for discounts to be allowed on the debtor's outstanding balance sheet date. The procedure for dealing with this is similar to the allowance for doubtful debts. It must be borne in mind that the estimate of discount to be allowed should be based on the net figure of account receivable less the allowance for doubtful debts, as it is obvious that provisions for a discount on debtors are not allowed on bad debts.

Example

On the 1st of January, 2000 Masantula started up a new business. During the year ended 31st December 2000 the following debtors were found to be bad and were written off on the dates indicated below:

Date		Amount (Shs.)
10.03.2000	Shelukindo	88,000
30.05.2000	Shemaombe	51,200
31.08.2000	Shekidele	9,600

On 31st December, 2000, the schedule of debtors amounted to Shs. 5,480,000 and after an examination, it was decided to make a provision for doubtful debts of Shs. 176,000.

Prepare the:

i. Bad debts account

ii. Provision for bad debts account

iii. Balance sheet extracts showing how debtors are displayed as on 31st December, 2000.

DR	BAD DEBTS A/C				CR
Date	Details	Amount	Date	Details	Amount
	Shelukindo	88,000	31/12/00	P&L	148,800
	Shemaombe	51,200
	Shekidele	9,600
		148,800			148,800

DR	PROVISION FOR BAD DEBTS A/C				CR
Date	Details	Amount	Date	Details	Amount
	Sundry debtors	176,000	31/12/2000	P&L	176,000
		176,000			176,000

BALANCE SHEET AS AT 31ST DEC 2000

LIABILITIES	ASSETS
	Current assets
	Debtors: 5,480,000
	Less provision for bad debts: 176,000
	5,304,000