Bad and doubtful debts are critical components of ledger accounting for businesses that offer credit to customers. Bad debts refer to amounts that are confirmed as uncollectible, while doubtful debts are amounts that might become uncollectible in the future. Proper accounting for these ensures accurate financial reporting and reflects the true value of accounts receivable. This example illustrates how to record bad and doubtful debts in ledger accounts with detailed journal entries.
1. Scenario Overview
ABC Company has the following accounts receivable at the end of the year:
- John Smith: $4,000
- Mary Johnson: $3,000
- David Brown: $2,000
Based on historical data, ABC Company estimates that 10% of its total accounts receivable may become doubtful. By the end of the year, John Smith’s $4,000 debt is deemed uncollectible and must be written off as a bad debt.
2. Calculating the Provision for Doubtful Debts
Total Accounts Receivable = $4,000 + $3,000 + $2,000 = $9,000
Provision for Doubtful Debts = 10% of $9,000 = $900
3. Journal Entries for Bad and Doubtful Debts
A. Creating the Provision for Doubtful Debts
Journal Entry (December 31):
Debit: Doubtful Debts Expense $900
Credit: Provision for Doubtful Debts $900
Doubtful Debts Expense Ledger
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision for Doubtful Debts Created | $900 | $900 Dr. |
Provision for Doubtful Debts Ledger
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision Created | $900 | $900 Cr. |
B. Writing Off Bad Debt (John Smith’s Account)
John Smith’s $4,000 debt is considered uncollectible and must be written off. The provision of $900 will cover part of this, and the remaining $3,100 will be recognized as a bad debt expense.
Journal Entry (December 31):
Debit: Provision for Doubtful Debts $900
Debit: Bad Debts Expense $3,100
Credit: Accounts Receivable – John Smith $4,000
Provision for Doubtful Debts Ledger (After Write-off)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision Created | $900 | $900 Cr. | |
| Dec 31 | Bad Debt Written Off (John Smith) | $900 | $0 |
Bad Debts Expense Ledger (Including Additional Write-off)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision for Doubtful Debts Created | $900 | $900 Dr. | |
| Dec 31 | Additional Bad Debt Expense (John Smith) | $3,100 | $4,000 Dr. |
Accounts Receivable Ledger (John Smith)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Jan 5 | Sale on Credit | $4,000 | $4,000 Dr. | |
| Dec 31 | Bad Debt Written Off | $4,000 | $0 |
4. Adjusting the Provision for Remaining Doubtful Debts
After writing off John Smith’s debt, the company reassesses the remaining accounts receivable of $5,000 (Mary Johnson and David Brown). A new 10% provision is created, requiring an additional $500.
Journal Entry (December 31):
Debit: Doubtful Debts Expense $500
Credit: Provision for Doubtful Debts $500
Provision for Doubtful Debts Ledger (After Adjustment)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision Created | $900 | $900 Cr. | |
| Dec 31 | Bad Debt Written Off (John Smith) | $900 | $0 | |
| Dec 31 | Provision Adjustment for Remaining Debts | $500 | $500 Cr. |
5. Impact on Financial Statements
A. Income Statement (End of Year)
| Particulars | Amount |
|---|---|
| Sales Revenue | $20,000 |
| Less: Bad Debts Expense (John Smith) | ($3,100) |
| Less: Doubtful Debts Expense (Provision) | ($1,400) |
| Net Income | $15,500 |
B. Balance Sheet (End of Year)
| Assets | Amount |
|---|---|
| Accounts Receivable | $5,000 |
| Less: Provision for Doubtful Debts | ($500) |
| Net Accounts Receivable | $4,500 |
6. Managing Bad and Doubtful Debts in Ledger Accounting
This example demonstrates how to create, adjust, and apply provisions for bad and doubtful debts in ledger accounting. Properly managing these entries ensures accurate financial reporting and helps businesses maintain the integrity of their financial statements while mitigating credit risk.