-This question was submitted by a user and answered by a volunteer of our choice.
Meaning of Bad debts
As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business.
So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the business and it may arise due to reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts.
Yes, bad debts are recorded in the Income statement. The Income statement shows the aggregate financial position of a business during a specified period by displaying the amount of revenue generated and expenses incurred by a business. Bad debts being an expense are recorded under operating expenses in the Income Statement or on the debit side in the Profit & Loss a/c.
Example
ABC Ltd. sells goods to a retailer for 40,000 at 50 days credit. However, after 50 days, the company realizes that the retailer has been declared insolvent and the amount is no longer recoverable. This amount of 40,000 is an expense for ABC Ltd and leads to a fall in the accounts receivable.
The journal entries to be recorded in the books of ABC Ltd are as follows:
| Bad debts a/c | Debit | 40,000 | Debit the increase in expense |
| To Retailer’s a/c | Credit | 40,000 | Credit the decrease in asset |
(being amounts written off as bad debts transferred to bad debts account)
| Profit and loss a/c | Debit | 40,000 |
| To Bad debts a/c | Credit | 40,000 |
(being bad debts transferred to profit and loss a/c)
Bad debts as shown in the Income statement
(Extract of Income Statement)
| PARTICULARS | AMOUNT | AMOUNT |
| Revenue | 8,00,000 | |
| Expenses: | ||
| COGS | 50,000 | |
| Insurance expense | 60,000 | |
| Depreciation expense | 20,000 | |
| Bad debts expense | 40,000 | |
| Total Expense | 1,70,000 |