Accounting Tutorials – Page 19

This accounting tutorial article provides a thorough explanation and analysis of what a bad debt expense is, what journal entry is made, and a look at provisions and recoverable amounts. A bad debt relates to amounts owed to us and for which we think there is a high chance we will not receive the money. Bad debts also relate to amounts that we consider as not recoverable anymore. For example, we may have to write off a customer's debt if they enter into liquidation. It is important not to confuse the bad debt provision with the debts written off. The former is a provision created because some debtors will not pay (a general provision). The latter relates to specific accounts receivable balances that we think will not be paid and will need to be written off. Allowance for Receivables and Other Bad Debts Companies often create a general provision for the amounts that their customers owe to them. Such provisions are usually calculated as a percentage of the total accounts receivable. For example, companies estimate 5% of the total accounts receivable might not pay. Other companies prefer to use the ageing of their debtors and create a provision based on that. For example, a company might choose to make a provision of 20% of the accounts receivable for debtors that are older than 90 days, 15% for debtors that are older than 60 days, 5% for debtors that are older than 30 days etc. There is no rule for the amount that each company should allow. Each company should create a provision based on the customers' profile, economic situation, and business nature. Bad Debt Expense When a provision is created, a journal will need to be posted. Explanations for the journals are provided below, but briefly, the bad debt expense is an income statement account where the movement in the bad debts and the write off of the irrecoverable debts is posted. The Journal Entry for Bad Debt Expense The journal entries you will need to make depends on whether a general or specific provision needs to be created or whether a debt balance needs to be fully or partially written off. Journal entries for a provision for bad debts Let's assume that a company has made $200,000 in credit sales and has a $200,000 accounts receivable balance. Let's say that a 10% bad debt provision is considered appropriate. In this case, make the following journal entry. DateAccount NameDebitCredit15 AprilBad Debts Expense$20,000Bad Debt Provision$20,000 The first account is included in the expenses (income statement account), while the second account is a current liability (a provision). Now, let's assume that the following year, the company has an opening (brought forward) bad debt provision of $20,000. The company now thinks that a $25,000 bad debt provision is necessary. It's not the entire $25,000 that will be posted on the income statement but the movement or, in other words, the additional provision that is needed. In this case, the journal entry to record the bad debt expense would be: DateAccount NameDebitCredit15 AprilBad Debts Expense (IS)$5,000Bad Debt Provision (BS)$5,000 If the company wanted a $15,000 provision instead of $25,000, we would have to reduce the $5,000. The journal that is necessary to facilitate the bad debt provision is the following: DateAccount NameDebitCredit15 AprilBad Debt Provision (BS)$5,000Bad Debt Provision (IS)$5,000 Journal entry to write off a bad debt expense provision If you have a receivable on your statement of financial position that you don't consider as recoverable anymore, you will need to write it off. These balances are often called irrecoverable debts. The difference between these debts and bad debts is that writing off bad debt will reduce the accounts receivable but will not affect the bad debt provision. For example, if a company made a credit sale of $2,000 to a customer that subsequently went into liquidation, writing off the balance might be appropriate. The journal, in this case, is the following: DateAccount NameDebitCredit15 AprilBad Debt Provision (BS)$2,000Accounts Receivable (BS)$2,000 Journal entry for recovered but previously expensed bad debt Sometimes companies write off debts that are subsequently paid (recovered). If a company recovers a previously written off balance, then a journal will need to be posted to reverse the effect on profit and loss. For example, if you recover the $2,000 that was written off (see above), then the following entry would be made: DateAccount NameDebitCredit15 AprilCash (BS)$2,000Bad Debt Expense (IS)$2,000 Conclusion We trust this tutorial has helped your understanding of the journal entries involved with the bad debt expense, provisions and recoveries. As always, we welcome your comments and feedback.