Bad dets and doubtful debts

Bad Debt refers to the sum due from the debtors, which remains unrealized, and so they are
written off in the company’s books of accounts. As against, doubtful debts refer to the debt,
with which there is an uncertainty, as to the degree to which amount will be recovered from
the debtor.
Who are Debtors?

Goods and services are sold for the purpose of generating revenue for the business. However,
all the goods are not sold in cash, and goods on credit are allowed to a number of customers.
So, the customers to whom goods are sold on credit are called debtors.

What is a Debt?

If out of the total sum due, a certain percentage of the sum is not recovered due to non-
payment, and the amount due from debtors is called debt.

This post will enlighten you on the difference between Bad Debt and Doubtful Debt.

BASIS FOR
BAD DEBTS DOUBTFUL DEBTS
COMPARISON

Meaning Bad Debts amounts to that portion of Doubtful Debt is the debt whose
the debts which are either recovery is not certain, i.e. it may
irrecoverable or whose probability of or may not be received.
recovery is very rare.

Closure of Debtor's Bad Debt Account (Debit), Debtor's The debtor's account, whose debt
Account Account (Credit) is recognized as doubtful is never
closed.

Type of Loss Actual Loss Anticipated Loss

Claim against Does not exists Exists

debtor

Tax-Deductible Yes No

Related to Specific Debtor All the debtors taken together

Accounting Amount of bad debt is deducted Provision for doubtful debt is

 BASIS FOR
BAD DEBTS DOUBTFUL DEBTS
COMPARISON

Treatment from the amount of sundry debtors
and the loss arising due to bad debt
can be charged against the Profit and
Loss Account or it can be adjusted
against Provision for bad debts
account.
created which is a charge against
profit that may cover the loss if the
doubtful debt turns out as bad
debt.

Debt Recovery The amount is credited to a bad debt
recovery account or bad debt
dividend account and its balance is
transferred to the profit and loss
account.
When doubtful debt is realized, the
amount is credited to the debtor's
account. And the provision created
for the doubtful debt is treated as
gain and so it is transferred to a
profit and loss account.

How it is shown in Bad Debt is not a part of sundry Doubtful Debts are a part of
the Balance Sheet? debtors and so it does not appear in sundry debtors for the purpose of
the balance sheet. creation of balance sheet and
provision for doubtful debts appear
as a deduction from sundry
debtors.

Definition of Bad Debts

When goods are sold to the customer on credit and the customer does not pay the outstanding
sum and he/she is declared bankrupt by the Court, then the amount owed by that customer is
considered as a bad debt, which is a loss to the firm. The amount which is not recovered is a
loss, for the business.

There are instances when a customer does not pay the entire amount of the debt and pays
only a certain percentage of it. the amount recovered from the debtor is credited to Bad
Debts Recovered Account. And, the remaining portion which is not recovered from the
debtors is called bad debt.

The concerned debtor’s account is closed in the books of the firm and at the end of the
period, the bad debt’s account is transferred to the debit side of the Profit and Loss Account.
Reasons for Bad Debt

Debts usually turn out as bad because of:

 Sudden demise of the customer whose assets are not sufficient to pay off debts.
 When there is a dispute with the customers.
 When the debtor is declared insolvent by the Court and he is not able to pay the due
sum.
 When the customer is dishonest, wherein the party has received goods on credit
having no intention to discharge the debt.

What is Provision for Bad Debts?

When it is expected that the outstanding amount to the customers will not be recovered, it is
advisable to recognize the anticipated loss. This can be done by decreasing the current year’s
profit and entering the amount to the credit of the special account, i.e. Provision for Bad
Debts.

Definition of Doubtful Debts

Doubtful Debt refers to that portion of debt whose recovery is not certain. Therefore, for such
debts, there is a possibility that the firm may face losses in the future.
At the end of the financial year, the balances due to customers’ accounts are calculated and
the portion which is likely to be irrecoverable is estimated. In practice, the amount whose
recovery is uncertain cannot be treated as a loss on the date at which the balance sheet is
prepared and so it cannot be written off. However, based on the past history of the firm, it
needs to be charged against the Profit and Loss Account of the firm.

Also, with the purpose of protecting against the probable loss, a provision is created
called Provision for Doubtful Debts. The provision creates a charge against profit. When we
create provision, a certain sum is set aside, so as to make good the loss, if the doubtful debt
turns out as bad debts.

Reasons for Doubtful Debts

Debts usually turn out as doubtful because of:

 When a customer is facing cash flow issues.

 When a customer is taking an abnormally long time to clear the debt
 When operational inefficiencies such as strikes, lockout, disruption in production, etc.
are experienced by the customers, resulting in financial difficulties.

What is Provision for Doubtful Debt?

Provision for Doubtful Debt implies the provision made to offset losses of anticipated bad
debts, that may arise in the future, using a predetermined percentage of the Sundry Debtors,
so as to ensure certainty in the amount of bad debts charged to each financial year.
Key Differences Between Bad Debts and Doubtful Debts

After having an in-depth discussion on the meaning of the two terms, now we will discuss the
differences between bad debts and doubtful debts:

1. Bad Debt refers to the amount which a customer owes to the firm, whose likelihood of
recovery is remote as it turns out as irrecoverable. As against, doubtful debt implies
the amount which a customer owes to the firm, but whether they will be receivable or
not, cannot be ascertained on the date of preparing the financial statement.
2. In case of bad debts, the debtor’s account is closed by debiting the bad debt account
and crediting the debtor’s account. As against, when it comes to doubtful debts, the
debtor’s account, whose debt is identified as doubtful is not closed.
3. While bad debts represent actual loss, doubtful debts represent anticipated loss. This
is since doubtful debts have the probability of turning out as uncollectible in the
future, but in the case of bad debt, they are clearly recognized as uncollectible.
4. As in the case of bad debt, the amount due is written off in the books of accounts, so
the claim against the debtor does not exist, whereas in the case of doubtful debts, the
debtor’s account is not closed, so the claim against debtors exists.
5. As bad debt is an actual loss to the firm, it is tax-deductible in nature, whereas
doubtful debt is just an anticipation of loss that may or may not occur in the future, so
it is not tax-deductible.
6. When a specific debtor defaults in the payment of the amount due from him, it
amounts to bad debt. As against, when there is uncertainty as to the recovery of the
amount due from various debtors, it is termed as doubtful debts.
7. In accounting, the amount of bad debts is deducted from the number of sundry
debtors. Further, the loss occurring due to bad debt can be charged against the profit
and loss account, or the amount is adjusted against the provision made in this regard.
Conversely, for doubtful debts, a provision is created, which is a charge against profit,
so as to cover the loss if the doubtful debt turns out as bad debt.
8. In case of bad debts as the debtor’s account is already closed, so when he pays the
amount either fully or partially, the amount cannot be credited to his account, rather
the amount is credited to a bad debt recovery account or bad debt dividend account
and its balance is transferred to profit and loss account. In contrast, in the case of
doubtful debts when the amount due to the debtor is realized, the amount is credited to
the debtor’s account. And the provision created for the doubtful debt is treated as gain
and so it is transferred to a profit and loss account.
9. As Bad Debts is not a part of sundry debtors and so it is not shown in the balance
sheet of the firm. Oppositely, Doubtful Debts are a part of sundry debtors for the
purpose of creation of the balance sheet, and provision for doubtful debts appears as a
deduction from sundry debtors.

Journal Entries for Bad/Doubtful Debt

 For writing off Bad Debt: As the amount is irrecoverable from the debtor, it is not
right to show the amount due as an asset, and so the amount of the respective
customer is closed by crediting the same.

 Transfer of Bad Debt Account to Profit and Loss Account

  For Creation of Provision for Bad and Doubtful Debt

 When provision for Bad Debts has been created, then the bad debts need to be
written off from the provision first. The entry will be:

 On the recovery of the amount, it is treated as a profit. The entry for the same is:

Important: It is worth noting that no entry will be made in the customer’s account until the
amount due is actually written off.