Bad debts and Provision for Bad debts

1. Bad debts and Provision for Bad debts

2. Bad Debts • When the firm finds that it is impossible to collect a debt, that debt should be written off as a bad debt. • Accounting Entries: Dr Bad Debts Cr Debtor With the irrecoverable amount of a debt

3. Example • During the year, a company sold goods for $2,000 to Mr. Lee, $1,500 to Mr.Wong and $300 to Mr. Wu. • Mr. Lee and Mr. Wong paid the company $800 and $1,000 respectively • Later, Mr. Wong and Mr. Wu became bankrupt, and it is impossible for the company to collect these debts. • The company decided to write these off as bad debts.

4. Mr. Lee $ $ Balance c/d1200 Sales 2,000 Bank 800 2,000 2,000 Mr. Wong $ $ Bad Debts500 Bank 1,000 Sales 1,500 1,500 1,500 Mr. Wu $ $ Sales 300 Bad Debts 300 Bad Debts $ $ Profit & Loss Acc800 Mr. Wong 500 Mr. Wu 300 800 800

5. B. Bad Debts Recovered • Bad debts recovered refers to debts formerly written off to be recovered later.

6. Accounting entries

7. Example • The following balances were part of the trial balance of Mr. Chan on 31 December 2006: $ Debtors 10,000 Bad Debts 1,000 • During the year, Mr. Chan received $300 and $1,200 from debtors, whose debts had been previously written off as bad debts in the current year and last year respectively. No entry has been made for these transactions

8. Bank 2006 $ Dec 31 Debtors 1,500 Debtors 2006 $ 2006 $ Dec 31 Bal b/d 10,000 Dec 31 Bank 1,500 Dec 31 B.D.R 300 Dec 31 B.D.R. 1,200 Bad Debt 2006 $ 2006 $ Dec 31 B.D.R. 300 Dec 31 Bal b/d 1,000 Dec 31 P & L 700 1,000 1,000 Bad Debt Recovered 2006 $ 2006 $ Dec 31 Bad Debt 300 Dec 31 Debtors 300 Dec 31 P & L 1,200 Dec 31 Debtors 1,200 1,500 1,500

9. Profit and Loss Account for the year ended 31 December (Extract) 2006 $ $ Gross profit X Add: Bad Debt Recovered 1,200 Less: Expenses Bad Debt 700

10. C. Provision for Bad / Doubtful Debts • A provision for bad and doubtful debts may be made when a firm thinks that there will be problems in recovering a debt.

11. Accounting entries

12. Increase in provision for bad debtsExample A firm decided to make a provision for bad debts at 10% of the debtors’ accounts which totaled $50,000 on 31 December 2004. On 31 December 2005, the debtors accounts totaled $60,000. The firm maintained the provision at 10% of its total debtors.

13. Provision for Bad Debts 2004 $ 2004 $ Dec 31 Balance c/d 5,000 ($50,000 * 10%) Dec 31 Profit and loss 5,000 Profit and Loss Account for the year ended 31 December (Extract) 2004 $ $ Gross profit X Less: Expenses Increase in provision for bad debt 5,000 Balance Sheet as at 31 December (Extract) 2004 Current Assets 50,000 Debtors Less: provision for bad debt 5,000 45,000

14. Provision for Bad Debts 2004 $ 2004 $ Dec 31 Balance c/d 5,000 ($50,000 * 10%) Dec 31 Profit and loss 5,000 2005 2005 Dec 31 Balance c/f ($60,000*10%) 6,000 Jan 1 Balance b/d 5,000 Dec 31 Profit and Loss 1,000 6,000 6,000 Profit and Loss Account for the year ended 31 December (Extract) 2004 2005 $ $ $ $ Gross profit X X Less: Expenses 1,000 Increase in provision for bad debt 5,000

15. Balance Sheet as at 31 December (Extract) 2004 2005 Current Assets 50,000 60,000 Debtors Less: provision for bad debt 6,000 5,000 45,000 54,000

16. Decrease in Provision for bad debtsExample The debtors’ accounts on 31 December 2006 totaled $40,000. The firm decided to maintain the provision at 10% of the total debtors.

17. Provision for Bad Debts 2004 $ 2004 $ Dec 31 Balance c/d 5,000 ($50,000 * 10%) Dec 31 Profit and loss 5,000 2005 2005 Dec 31 Balance c/f ($60,000*10%) 6,000 Jan 1 Balance b/d 5,000 Dec 31 Profit and Loss 1,000 6,000 6,000 2006 $ 2006 $ Jan 1 Bal b/f 6,000 Dec 31 Profit and Loss 2,000 • Balance c/f • ($40,000*10%) 4,000 6,000 6,000

18. Profit and Loss Account for the year ended 31 December (Extract) 2006 2004 2005 $ $ $ $ $ $ Gross profit X X X Add: Decrease in provision for bad debts 2,000 Less: Expenses 1,000 Increase in provision for bad debt 5,000 Balance Sheet as at 31 December (Extract) 2004 2005 2006 Current Assets 40,000 50,000 60,000 Debtors Less: provision for bad debt 6,000 4,000 5,000 45,000 54,000 36,000