Bad Debts

Bad Debts

Bad debts are amounts owed to a firm by its debtors that the firm has determined it will never be able to collect. When a debtor fails to pay — due to insolvency, disappearance, or outright refusal — the amount due becomes a loss for the business. This loss is called a bad debt.

The fundamental accounting treatment is straightforward: the loss is recognised by debiting a Bad Debts Account (an expense/loss account) and crediting the Debtors Account (an asset account) to remove the uncollectible amount from the books.

Bad Debts Already in the Trial Balance

In Ankit's trial balance, bad debts of ₹4,500 appear as a separate item. This means that during the year, Ankit has already recorded this loss in his books — the entry was passed, the debtors were reduced, and the bad debts account was debited. When such an item appears in the trial balance, it is treated as a direct expense and is shown on the debit side of the Profit and Loss Account. No further adjustment to debtors is needed for this amount because the debtors figure in the trial balance (₹15,500) already reflects the reduction from that earlier write-off.

Further Bad Debts (Additional Information)

Now consider a new situation: after the trial balance was prepared, Ankit learns that one of his debtors who owed ₹2,500 has become insolvent. Nothing is receivable from this debtor. This loss relates to the current year but has not yet been recorded in the books. This is called further bad debts.

The adjustment entry is exactly the same in form:

This entry has two effects:

• It reduces the value of debtors from ₹15,500 to ₹13,000 (₹15,500 – ₹2,500).
• It increases the total bad debts expense from ₹4,500 to ₹7,000 (₹4,500 + ₹2,500).

Treatment in the Final Accounts

In the Profit and Loss Account: The total bad debts (trial balance amount + further bad debts) are shown as an expense on the debit side. In Ankit's case, the figure is ₹7,000.

In the Balance Sheet: Debtors are shown at their revised value after deducting the further bad debts. The trial balance figure of ₹15,500 is reduced by ₹2,500, and the net realisable value of ₹13,000 appears under Current Assets.

The relevant extracts from Ankit's final accounts are shown below.

Trading and Profit and Loss Account of Ankit for the year ended March 31, 2017 (Extract)

Balance Sheet of Ankit as at March 31, 2017 (Extract)

| Liabilities | Amount (₹) | Assets | Amount (₹) | …