A bad debt is an amount which the business failed to collect from debtors because of various factors and is treated as an expense. It is written off when a debtor failed to pay the specific amount and the chances of recovering the money are close to zero after all reasonable efforts to collect the money has been applied.
How a bad debt is declared
Bad debt is declared when the debtor is pronounced bankrupt by the court, is awarded a certificate of bankrupt and does not have any other means of paying back the money owed. Moreover, a bad debt is written off if it is uneconomical to recover the money owed due to the costs and regulations involved. If the costs of recovering the debt are higher or equivalent to the debt amount, then it is prudent to treat it as a bad debt. When a debtor relocates to another country where recovery costs may be equivalent to the amount owed, it is advisable to treat the debt as an expense to the company.
Accounting treatment of bad debt
A bad debt is the money lost to the business, hence is treated as an expense. It is written off by crediting the debtor’s account and debiting the profit and loss account. Before provision for bad debts, uncollected money is treated as provision for doubtful debts meaning those bills that are unlikely to be paid off as a result of disputes over supplies, conditions of the goods as well as signs of stress to customer operations. Business debts becomes an expense when there is non-longer any doubt that the money is uncollectable and is written off by debiting the expense account and crediting the debtor's account. A bad debt expense is recorded in the accounting period in which it is written off as per the matching principle of accounting for the treatment of revenue and expenses.
Methods of accounting for bad debt
It is accounted for through using the direct bad debt write-off method on which the uncollected money for trade receivables in the sales ledger is charged directly to the trading account. Besides, the allowance method can be used on which the bad debt estimate is done at the end of the accounting period