Bad Debts

Businesses normally sell goods and services to customers on credit terms. This gives rise to
debtors/ receivables in the books of accounts.
Often times, the entity may not be able to recover all balances outstanding in respect of certain
debtors/receivables. This means that the debt or outstanding amount is irrecoverable. Debts may
be deemed irrecoverable for various reasons including; customer going bankrupt, death, trade
dispute or fraud.
In accounting, debts or outstanding amounts that are deemed irrecoverable are referred to as Bad
Debts.
Every time an entity realizes that it unlikely to recover its debt from a debtor or receivable, and
as a result is deemed irrecoverable, it MUST ‘write off’ the debt from its books as being BAD.
This ensures that the entity’s assets (i.e. debtors/ receivables) are not stated above the amount it
can reasonably expect to recover which is in line with the concept of prudence (the use of
cautious accounting principles).
NB: Any amount written off as a Bad Debt is an EXPENSE to the business, and as such MUST
be charged to the PROFIT and LOSS Account

Accounting Entries required to write off a Bad Debt

Debit: Bad Debt Expense
Credit: Debtor/ Receivable Account

Example 1
On Jan 1, 2020, ABC LTD. sells goods to DEF LTD. for $500 on credit. Subsequently on March 31,
ABC LTD finds out that DEF LTD has been declared bankrupt and is being liquidated, therefore the
prospects of recovering its dues are very low, and as such, the amount is deemed irrecoverable.
ABC LTD. should therefore write off the debtor/ receivable amount from DEF LTD in view of the
circumstances. The accounting entries needed to be recorded as follows:

The Journal

Date Details Dr Cr
Mar 31 Bad Debt 500
DEF LTD 500
Being as to the “writing off” of debt deemed irrecoverable
Example 2
On Jan 1, 2020, ABC LTD. sells goods to DEF LTD. for $500 on credit. Subsequently on March 31,
ABC LTD finds out that DEF LTD has been declared bankrupt and is being liquidated. DEF LTD.
however pays ABC Ltd a cheque of $350 in full settlement of the debt.
ABC LTD. should therefore make the accounting entry for the receipt of the cheque and write off the
outstanding debtor/ receivable amount from DEF LTD as bad. The accounting entries needed to be
recorded as follows:

The Journal

Date Details Dr Cr
Mar 31 Bank 350
Bad Debt 150
DEF LTD 500
Being as to the “writing off” of debt deemed irrecoverable

****NB: In this case, the bad debt is equal to $150, as a payment of $350 was made on the original
amount owed ($500).
Working:
Original Amount Owed $500
Payment by Cheque ($350)
Bad Debt $150