Bad debt refers to loans or outstanding balances owed that are no longer deemed recoverable and must be written off. This expense is a cost of doing business with customers on credit, as there is always some default risk inherent with extending credit.
How to Record Bad debts and Bad Debts Recovered
First step, create the Bad debts and bad debts recovered account.
For that Go to Accounting > Chart of Accounts > New Account.
Fill in all the details:
Enter the account name - Provide the name of new account head in Name
Select account group from the drop down - Select the corresponding group for new account head in drop down menu.
Enter the effective date - Record the effective date of account creation.
Opening balance- NILL (there is no need for opening balance as it is an income and expense account).
Click on save and its Done.
Second step is for recording of bad debts and bad debts recovered.
For that user have to pass journal entries. To pass journal entry follow the below-mentioned steps:
Recording of bad debts
Step 1: Go to Accounting > Journal Entries, click on "Add New Record".
Step 2: Fill in the details like Date, Under project, if any.
Step 3: Under From Account select bad debts and debit it with the amount and select debtors account and credit it with the same amount.
Step 4: Fill the description box for eg. "Being bad debts recorded" and
Step 5: Click on save and it's done.
When these Bad debts are recovered then the user has to pass journal entry for bad debts recovery. For that follow the below steps:
Recording of bad debts recovered
Step 1: Go to Accounting > Journal Entries, click on "Add New Record".
Step 2: Fill in the details like Date, Under project, if any.
Step 3: Under From Account select bad debts recovered account and debit it with the amount recovered and select bad debts account and credit it with the same amount.
Step 4: Fill the description box for eg. "Being bad debts recovered", user can also add the customer's name from whom the amount is recovered
Step 5: Click on save and it's done.
For better clarity of what is Bad Debts please refer to this example:
Say a Company ABC sells goods on retail to a retailer at 90 days credit. The company has recorded accounts receivable in its Balance Sheet and has also recognized the revenue. After the 90 days, the company realizes that the debtors have gone bankrupt and now will no more pay the debt. Thus, the money is irrecoverable and is now, considered bad.
Hence, the company has both the bad debts and the provision account (Provision for Credit Losses). The company has to maintain such accounts as it is not necessary that all of their accounts receivable will pay their debt. Hence, the company will enter this irrecoverable amount into its books of accounts on the debit side of the Income Statement as an expense. In the balance sheet, the accounts receivable will also get reduced by the same amount as are now irrecoverable.
Now when these bad debts are able to pay any amount to the company these are considered as recovery of bad debts and hence recorded as income against Bad debts.