Whenever we hear the word ‘Bad Debt’ it leaves scary footprints in our mind. In simple terms, it is stated as a receivable amount that can never be recovered, which again turns to be a tough task. In the business world, it becomes essential to keep a track on the cash being lent and the amount that gets recovered.
You need to know that a good debt will increase and strengthens your business relations whereas bad debt can completely change the game. So, it becomes essential for you to keep track of these footprints, and this is how the bad debt accounting comes into the picture. This branch of accounting helps you to identify who your unpaid customers are, how much you have lent, details regarding the period of recovery etc. Let’s dive in and understand more about it.
What is a Bad Debt Accounting?
When a company identifies the total bad-debt it holds in its books of accounts; it needs to prepare a separate section of reports. This section tracks the total bad debts to be recovered and gives a clarity to the business regarding its incapable customers.
The concept of bad-debt might arise because of the essential reasons:
- A situation wherein the company extends too much of credit to its customers, without keeping a proper record
- A case wherein the customer tries to indulge himself into the fraudulent activities or holds no intention to repay.
Now, it both the scenarios, it becomes essential to keep a track and maintain bad-debt records, which can be done by implementing the two methods. To do so, there exist two ways.
1. Direct Write-Off Method
In this method, the uncollectible amount is identified first as a Bad-Debt, and then is removed from the Accounts Receivable Account
2. Allowance/Provision Method
Here, the amount is debited from the Bad-Debts account and is credited to Allowance for Doubtful Accounts regarding an estimated amount
Apart from the reasons mentioned above, let’s have a look at a few more reasons that provokes a business to maintain bad-debt transactions.
Reasons for Bad Debts
Few points that state the reason behind the existence of Bad Debts is as follows:
- Poor Money Management on both the ends – loaner as well as loanee
- Lack of traceability from the company’s front
- Excess lending without checking the debtors’ creditworthiness
- Failure to maintain a proper debtors record
- Financial Illiteracy or negligence on both the ends
- Failure to maintain a proper creditor’s record
Apart from the above-stated reasons, there exists another vital aspect that becomes extremely important for you to know regarding bad-debt, and it is provision for bad debt.
Provision for Bad Debt or Doubtful Debt
Now, you must be wondering what a doubtful debt is. Is it the same as Bad Debt? Well, the answer is no it is not. A doubtful debt is a money that exists in an uncertain stage of receiving an amount, whereas a bad debt is a debt that is officially regarded as uncollectible.
Importance of Bad Debt Accounting
Since we have seen what a bad debt is all about, let’s have a look at the importance of maintaining bad debts accounting:
- It keeps track of the over-all bad debts regarding a particular financial year
- It helps the business organisation to identify its current assets
- Business organisations can write-off bad debts against taxes
- Managing the bad debts leads the company’s credit policy
- It helps in effective management of cash-flow
- Business environment can change anytime if customers fail to pay their debts. So, it’s safe to be prepared for having a bad debt account ready
Maintaining a bad-debt account can help your business to flourish and get the bad-debts recover at an early stage. This process needs an in-depth analysis and it becomes a tedious job. Moreover, it turns out to be a time-consuming process. So, the best way to get it covered is to outsource the bad-debt accounting to professionals. Subject-matter experts handle multiple scenarios and possess in-depth knowledge. They can help you in figuring at the possible ways to recover your bad debts.
If you are looking for one, Jaxa is here to help you. We stand as one of the top accounting firms in UAE. Our accounting experts can help you in taking the first step towards recovering your bad-debt. We have been dealing with multiple clients and has been supporting them in managing their audits and accounts. For further information on managing your bad debts, do contact us, we’d be glad to assist.