Meaning of bad debt
In business, traders allow credit facilities to their customers where by traders will be the creditor while the buyer becomes the debtor. Inability to pay at the specified time makes the debt to become bad.
Bad debt therefor are debts which have become irrecoverable, this arises as a result of inability of the customer to pay back his/her debts
Cause of bad debt
- Death of a debtor: The death of the debtor automatically makes a debt bad except the family member of the diseased are willing to pay off the debt of their dead relatives
- Insolvency or bankrupt: A debt can also become bad if the debtor is not making profit and even gotten to the stage of selling his asset to run the business; he therefore finds it difficult to pay his debt.
- Poor money management: Inability to manage available resources
- Financial illiteracy: Lack of knowledge about money can make a person find it difficult to pay his/her debt
- Sickness: A sick person is weak and they have no power to work with the money borrowed, the debt becomes bad cause of the inability to pay back
Bad debt appears at the debit side of profit and loss account as a charge on the expenses side. It therefore reduce the account of debtors in the balance sheet as well as the net profit of the business.
Profit and loss account
Expenses
Salaries xx gross profit xx
Wages xx
Electricity xx
Insurance xx
Depreciation xx
Bad debt xx
Net profit xx
Provisions for bad debt
They are amount set aside out of profit to provide for debts which cannot be determined .It is an estimated expenses for bad debt, because it is charged in profit and loss account as an expenses.
Bad debt recovery
Recovery of bad debt and doubtful debt occurred when the debtor pays back what has already been written off
In business when a debt has stayed so long and has been written off from the books of account via the profit and loss account and the balance sheet for the trading period.
However, it is possible to recover debts written off earlier,when this occur the bookkeeping procedure are as follows
Debit: debtors account
Credit: bad debt recovered account.
When cash is recovered from debtors
Credit: debtors account
Exercise
- Define bad debt
- When a debt is recovered; state what happens to the debtors account in book keeping
- Under profit and loss account; bad debt is treated as———-
- Explain the meaning of provision for bad debt
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