Bad Debts

Definition
When customers owe the business money after sales on credit to them and they can
not pay their debts for some or other reason and the business decides to write of the
debt as irrecoverable.
If customers become insolvent or are liquidated, they sometimes are unable to pay
their debts. Some customers disappear without a trace. In all these circumstances
the business will not be able to collect the money being owed to them. This is called
bad debts. We write of the bad debts in the general journal. Sometime the estate of
the liquidated company does pay out some portion of the debt and the business will
receive a portion of the money owed to the and the rest must be written off as
irrecoverable. Bad debts is an expense account and will fall under owners’ equity.

Let’s have a look at an example:

Mr T owes your business R10 000. He goes into liquidation and his estate estimates
that he can only pay 40cents for every rand that he owes you.
So, the business will receive R4 000 (10 000 x 40%) and R6 000 will be written of as
bad debts.

T-Accounts:
Bank
Accounts Receivable 4 000

Accounts Receivable
Bank 4 000
Bad Debts 6 000

Bad Debts
Accounts Receivable 6 000

His debts have decreased with the full R10 000 as he paid R4 000 and the
remainder was written off. Back increased with the R4 000 we received, and we
created an expense account for Bad debts that was written of, R6 000. Its an
expense so it will decrease profits and therefore on the debit (minus side) of the
account.
The R4 000 we received will be recorded as a normal receipt in the CRJ and the
source document will be a duplicate receipt.
The R6 000 written off will be recorded in the General Journal and a narration will be
required to explain why it was written off.