Bad Debt Accounting

Nov 2018

Whenever we hear the word ‘Bad Debt’ it leaves scary footprints in our mind. A business involves itself into multiple financial transactions in a single day. The term ‘Bad Debt’ is used when the business organization loses all its hope and is unable to recover the necessary amount for the service it provides.  As stated by Robert Kiyosaki, “Good debt is a powerful tool but a bad debt can kill you.” On the business front, good debt increases and strengthens business relations whereas bad debt can completely change the game. So, these footprints are necessary to track down for a business entity and that’s how bad debts accounting comes into the picture. Let’s understand it in a detailed way.

What is a Bad Debt Accounting?

As soon it is identified, the bad debts entry should be written off by the debt collector from the affected debtor’s account. In case there is no debtor account, an account receivable account is generated. This procedure of recording the bad debts transaction is known as Bad Debt Accounting. To compute Bad Debts Expense, 2 methods are used:

1. Direct Write-Off Method

In this method, the account identified as Bad-Debt 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

Another important question that you should know if you are an entrepreneur or even if you already have an established business is “Why Bad Debts happen?” Well, the answer to this question lies in the following reasons.

Reasons for Bad Debts

The reasons that give birth to bad debts lie in both the ends of the business organization as well as a debtor. 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

Another important aspect that becomes extremely important 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 stills holds in the doubtful stage of receiving an amount, whereas a bad debt is a debt that is officially regarded as uncollectible.

The main aim here is to get the bad debts recovered and that is why it plays a very important role in business organizations. Let’s have a look at them.

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 maintain bad debts accounting:

  • It keeps a track of the over-all bad debts regarding a particular financial year
  • It helps the business organization to identify its current assets
  • Business organizations can write-off bad debts against taxes
  • Managing the bad debts manages 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

Thus, we have seen that how important it becomes to manage the bad debts of a company. Be it a national or a multi-national organization, bad debt maintenance is a must, and the sooner it gets managed, the better. Now, maintaining the bad debts turns in between the tons of work turns out to be a complex task. The safest and fastest way that you can opt for is to outsource your bad-debts work to an experience accounting consultant who is well-versed with the accounting policies. This will not only save time but also helps you to get a clear picture of your bad-debts and solutions to sort the issues which will, in turn, boost the company’s profit. Wondering where will you find an accounting consultant or whom to contact? Don’t worry. Jaxa, accounting consultants with over a decade of experience in the UAE, can be your best accounting guide. We have been dealing with multiple clients and has been helping them in managing their audits and accounts. For further information on managing your bad debts, do contact us, we’d be glad to assist.