Bad Debts

Bad debts are the expenses which appear in the income statement. These actually arise due to making sales on credit terms. If an entity wants to avoid the risk of bad debts, it may stop selling on credit terms. But this will affect the entity’s sales badly and the entity has to suffer from severe loss. In order to avoid the loss, the entity has to sell goods and services on credit terms. But it has to implement some sorts of criteria to screen out the customers so that a very low % of accounts receivable turn into bad debts.

Method of Recording

 There are two methods of recording bad debts expense as under:

 1. Direct method

 Under direct method, we do not create Allowance for doubtful account.  Instead, we pass on the journal entry of bad debt once the amount gets confirmed. 

  Debit Credit
Bad debt expense xyz  
Accounts Receivable   xyz

 

 2. Indirect Method

 This method is also called Allowance for Doubtful Account method. Under this method, an accounting estimate is formulated and applied to either accounts receivable ending balance or the sales figure of the reporting period. Then, following entry is passed on in the general journal: 

  Debit Credit
Bad debt expense xyz  
            Allowance for  doubtful debt   xyz
     
Allowance for bad debt ABC  
            Accounts Receivable   ABC