Bad Debts

A bad debt is an amount that is written off by the business as a loss to the business and classified as an expense because the debt owed to the business is unable to be collected, and all reasonable efforts have been exhausted to collect the amount owed.

A person or company who is not expected to pay his debt; for example, because the company has gone into liquidation. Bad debts must be written-off and therefore they will reduce profit.

A bad debt becomes a bad debt when a business decides it is one, this decision is often based on past experience.  Decisions are made by keeping a list of all debtors (aged debtors), and reviewing this list periodically.

If a business is having difficulties collecting money owed from one of its customers it may decide to cancel the debt.  This is called a write-off and the accounts would need to be adjusted for this write-off.

A Bad Debt account would need to be set up and this would be an expense account.

To account for a bad debt there are in fact three transactions involved:

You would debit the Bad Debt account with the Net amount

Debit the VAT account with the VAT amount

Credit the Debtors Control account with the Gross amount

This type of transaction would affect both the profit and loss, and the balance sheet.  The profit and loss would show the bad debt as an expense as this is money owed by a customer that cannot be collected.

The transaction has previously processed as a debit to the Debtors Control account.  As it is money that can no longer be collected, you would reverse this by making a credit to the Debtors Control account.

A list of customers accounts are usually kept called Aged Debtors Control.  A decision to write-off a bad debt would be made by reviewing the Aged Debtors/Debtors Control.