Bad debt is an amount owed to a business that is considered—or proves to be—irrecoverable. There are several reasons why a debtor may fail to pay an amount due, including death, bankruptcy, insanity, and others.

Once a business is convinced that an amount due from a debtor is no longer recoverable, it is prudent to remove the amount from the books so that the figures in the books of accounts and balance sheet truly represent the amount due.

The entry required to write off bad debt is as follows:

  • Dr. Bad Debts account with the amount deemed irrecoverable
  • Cr. the debtor’s personal account with the amount deemed irrecoverable

Bad debts account is a nominal account and represents a normal business expense. At the end of each financial year, the balance on this account is transferred to the profit and loss account.

Example

John has learned that David, who owed him $960, has died and left no estate behind. John decides to write off this amount as a bad debt.

Required: Show the journal entry.

Bad Debts Journal Entry

The effect of the above entry is:

  • The Bad Debts account will show a debit balance of $960
  • David’s personal account, which previously showed a debit balance of $960, will be closed down (i.e., show a nil balance)

You can learn more about Bad Debts by checking the topics below:

Reduction in Provisions for Bad or Doubtful Debts

Recovery of Bad Debts

Provisions of Bad Debts

We have also prepared practical problems and solutions that can help you clarify the concept of bad debts.

Frequently Asked Questions

Can a bad debt be written off without being assigned to a debtor?

Yes. In certain cases, it may be necessary to write-off the entire amount of the loan/advance granted or due from a customer before you can determine which portion is irrecoverable and which portion is recoverable. Also known as: in full settlement of account.

What happens when a loan is repaid in part?

A loan is written off when the entire outstanding balance has been waived. This implies that it cannot be recovered from the debtor. If only a portion of the loans taken by a business from its creditors are repaid, then no account need be written off since it can be assigned today a particular debtor.

How long should bad debts be written off?

A debt must be written off when it becomes clear that it cannot be recovered. Usually, when no further amounts are to be received from the debtor concerned, the entry for writing off bad debt must be made in the books of account.

When can bad debts be written off?

Bad debt must always be included in the statement of financial position and is to be carried forward till such time as it is discovered that the debtor has paid or otherwise settled an amount that was previously (erroneously) assumed to be uncollectible.

When is an allowance for doubtful accounts or bad debts created?

A provision for doubtful accounts or bad debts is created when it becomes apparent that the debtor will not repay the amount due after full and reasonable efforts to collect the debt.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.