In Accountancy, a Bad Debt is an amount owed to a business by a customer (debtor) that cannot be recovered. This usually happens when the debtor goes bankrupt or becomes insolvent. Since the money is permanently lost, it must be recorded as a loss in the books of accounts.
At the end of the financial year, the balance in the Bad Debts A/c is transferred to the debit side of the Profit & Loss Account because it is an indirect loss to the business.
According to the Nominal Account rule: "Debit all expenses and losses." Since a bad debt is a loss for the business, the Bad Debts A/c is Debited.
According to the Personal Account rule: "Credit the giver." Since the debtor's account must be closed (as they won't pay), the Debtor's A/c is Credited.
When a debtor's full amount becomes irrecoverable:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Bad Debts A/c ... Dr. | Amount | |||
| To Debtor's A/c (Name) | Amount | |||
| (Being amount due from debtor written off as bad debts) |
Often, a debtor becomes insolvent, and their estate pays a fraction of the debt (e.g., 40 paise in a rupee). The received amount is cash, and the rest is bad debt.
Example: Ram owed ₹10,000. He became insolvent and only 40% was recovered from his estate.
| Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Cash/Bank A/c ... Dr. (40% received) | 4,000 | ||
| Bad Debts A/c ... Dr. (60% lost) | 6,000 | ||
| To Ram's A/c (Total settled) | 10,000 | ||
| (Being 40 paise in a rupee received from Ram, balance written off) |
Sometimes, a debt previously written off as bad is unexpectedly paid back by the debtor later. This is treated as a gain/income.
Rule: "Credit all incomes and gains."
| Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|
| Cash/Bank A/c ... Dr. | Amount | ||
| To Bad Debts Recovered A/c | Amount | ||
| (Being previously written off bad debt recovered) |
(Note: Do NOT credit the Debtor's personal account here, because you already closed their account when you wrote off the bad debt).
A provision for bad debts is an estimate made by the business at the end of the year for debts that *might* go bad in the future. It is created out of current profits as a precaution, adhering to the accounting Principle of Prudence (Conservatism).
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