Bad Debts, Budget For Doubtful Debts, and Recovery of Bad Debts

1. The main risk of credit sales is the potential for bad debts.

2. Bad debt is a debt that can not be recovered from the debtor

3. The reasons for bad debts are as follows:
(a)Debtors who intend to cheat have escaped and can not be traced (b)Debtor has passed away
(c)Debtor is declared bankrupt
(d)Debtor can not afford to pay

4. When bad debts occur, the relevant debtor’s account must be closed by crediting the debtor’s account.

5. Bad debt is a kind of business loss and must be fetched with revenue for the accounting period. This is in line with the concept of matching and the accounting period. Bad debts are transferred to the debit of Profit and Loss Account.

6. Bad debts are debited to the Profit and Loss Account whether the bad debts occur before or at the balance sheet date. No matter what bad debts are in the Balance Sheet or additional information, both must be debited to the Profit and Loss Account.

7. The bad debts recorded in the Balance Sheet are as follows:

(a) If bad debts occur before the balance sheet date, bad debts are in the Balance Sheet. Therefore, it can be deducted by the bad debt because the item is a net debtor.

(b) If bad debts occur at the balance sheet date, bad debts are present in additional information. Thus, the debtor in the Balance Sheet must be deducted from bad debts

Provision Of Doubtful Debts

1. The provision for doubtful debts is provision made for business debt which may not be recoverable. The provision means expenses that can not be calculated accurately.

2. Businesses should allocate or set aside some profits to cover net profit reduction as a result of bad debts.

3. The provision for doubtful debts is the loss or expense of the business which should be charged to the accounting period during the credit sale. The purpose of this adjustment is to match the yield to expenses within the effective accounting period.

4. Provision for doubtful debts is estimated at the end of the accounting period, based on experience, knowledge of its customers, and reviewing the tenure of its customers. The longer the debt has not been recovered, the more likely the debt becomes obsolete. Thus, the higher the estimated percentage is doubtful.

5. The provision for doubtful debts is calculated based on one per cent of the total amount of the debtors which may not be able to settle the debt:

Provision of doubtful debts = % (Debtor – Bad Debts) = % Net Debtor (Note: Do not deduct bad debts in the Balance Sheet. Just deduct bad debts in additional information.)

How To Record Provision For Doubtful Debts
1. Establishing Provision for Doubtful Debts.
When the provision of doubtful debts is established for the first time, its double notes are:
Profit and Loss Account Debit
Provision of Doubtful Debt Account Credit

Mr Bernedict Liew, a businessman has a debt of RM9,600 in his book on December 30, 1996. 5% of the debt is estimated to be non-recoverable.

Provision of Doubtful Debt = (5/100) X RM 9,600
= RM 480