Adjustment 2: Bad debts written
off
Formed and based on IAS 37
Mr. Barry
A-level Accounting Year 12
Bad debts
– A bad debt is a debt owing to a business which it considers will
never be paid back
– Sometimes debtors do not pay for the goods/services that
they are sold on credit to
– Based on prudence concept
– Bad debts are written off when they become uncollectable –
all efforts to be recovered have been exhausted
Mr. Barry
A-level Accounting Year 12
Bad Debts
• A large proportion of sales are made on credit
• Business is taking the risk that some of the
customers may never pay for the goods sold
to them – normal business risk
• Bad Debts are a normal business expense that
must be written off (Charged as an expense )
to the Income Statement at the end of the
year
Mr. Barry
A-level Accounting Year 12
Bad Debts – effects of not writing off
bad debts
• Effects of not writing off bad debts:
1) The profit will be overstated
2) The balance sheet will not reflect the correct
position – debtors (receivables) will be over
stated by the amount of the bad debt.
Mr. Barry
A-level Accounting Year 12
Treatment of Bad Debts
• Debit – Bad Debts written off account
• Credit – Debtor’s account
At the end of the year:
• Debit – Profit & Loss account
• Credit – Balance Sheet
Mr. Barry
A-level Accounting Year 12
Bad debts in the financial statements
• How are bad debts shown?
• Written as BAD DEBTS under expenses in the P&L
account (Income Statement)
• Deducted from Debtors in the Current Assets section
the Balance Sheet
• Bad debts are another form of non-cash expense – no
cheque is written out or cash paid
• Profit for the year will be reduced accordingly – this
may make owners less likely to draw out too much cash
from the business
Mr. Barry
A-level Accounting Year 12
Illustration - example
• Bob has produced a trial balance that includes the following figures:
Dr (£)
Cr (£)
• Bad Debts written off
516
• The fact that this amount is already in the trial balance shows that
the debt has already been written off and you are given no
instruction as regards to writing Off a bad debt.
• ACTION – Include the £516 as an expense in the income statement.
No further account required.
• Sometimes you are (most exam Q’s do) given an instruction to write
off a particular bad debt.
• In these circumstances, you will need to record the bad debt in the
P&L account as an expense AND also reduce debtors by the same
amount. In other words:
• Debit
Bad Debts written off (P&L acc)
• Credit
Debtors (Balance Sheet)
Mr. Barry
A-level Accounting Year 12
Bad Debts – worked example
THIS IS DONE BY:
Debiting a bad debts account in the general ledger AND Crediting
the debtor in the sales ledger
WORKED EXAMPLE
The following accounts appear in Noel Neils sales ledger:
DR
Mike
Balance b/d 143
Dr
Rett
Balance b/d 51
Dr
Derek
Balance b/d 628
Cr
Cr
Cr
Dr
Cindy
Balance b/d 619
Dr
Sandy
Balance b/d 430
Dr
Tina
Balance b/d 92
Cr
Cr
Cr
It has been revealed that Mike and Tina are unable to pay their debts
and Noel has decided to write them off at the year ended 31st
December 2005
REQUIRED: Show the necessary entries to record the transactions
Mr. Barry
A-level Accounting Year 12
ANSWER
Sales Ledger
Dr
Balance b/d
Mike
143
Cr
Bad Debts 143
Dr
Cindy
Cr
Balance b/d 92
Bad Debts 92
Dr
Mr. Barry
Bad Debts account
Mike 143
Tina 92
A-level Accounting Year 12
Cr
The journal entries would show:
Dr
143
Bad Debts
Mike
Cr
143
Writing off Mike’s Debt (irrecoverable) to the bad debts account
Bad Debts account
92
Tina
92
Writing off Tina’s debt (irrecoverable) to the bad debts account
At the end of the financial year the bad debts account is totalled
and closed by transferring the amount to the profit and loss
account as a revenue expense.
Dr
Mike
Tina
Mr. Barry
Bad Debts account
143
I/S
92
235
A-level Accounting Year 12
Cr
235
235
NOEL NEIL
Profit and Loss account extract for the year ended
31 December 2005
Expenses
Bad Debts
235
NOTE:
Writing off bad debts is done so by recording this
as an expense in the Income Statement account,
therefore reducing the amount of profit made
by the Company
Mr. Barry
A-level Accounting Year 12
Illustration - question
• Yansie has produced a trial balance that includes the following figures:
Dr (£)
Cr (£)
Bad Debts written off
120
Debtors
12,500
You are told that a debt outstanding from Joel of £350 is outstanding, but
will not be paid because Joel is now bankrupt.
Write off the debt outstanding from Joel
You are given a clear instruction to write off the bad debt
• ACTION – Increase bad debts written off by £350 and reduce debtors
by £350. The amounts to appear in the final accounts will be as
follows:
• Bad Debts written off £470 (£120 + £350)
• Debtors £12,150 (£12,500 - £350)
Mr. Barry
A-level Accounting Year 12
Questions
1. Tom Simmons has the following information at year end 31/12/2014:
Debtors
£50,000
It has come to his attention that a debtor owing £500 has gone into
liquidation and is unable to repay the amount owing
2. James O’Hara has the following information at year end 31/12/2014
Debtors
£60,000
Bad Debts £6,000
At year end James realised that a debtor has been declared bankrupt. He is
unable to pay the amount of £560
SHOW HOW TO ACCOUNT FOR EACH QUESTION
Ledgers and financial statement entries are required
Mr. Barry
A-level Accounting Year 12