Accounting for bad and doubtful debts

As credit people, it will be extremely unlikely if we have not come across a bad debt at some time or other. It is at such times that we like to remind ourselves - and others - that you cannot maximise profits without incurring the odd irrecoverable debt or two. Most businesses need to take on marginal business in order to make the expected returns and, unfortunately, we cannot get it right all the time. Customers do go bankrupt and cannot pay us and they do occasionally disappear without trace. It follows then, that credit personnel are likely to be sadly familiar with bad debts and should understand the treatment of them in the accounts. This is why accounting for bad and doubtful debts is an important topic in the Certificate stage 'Accounting' paper.

Definition

First let's distinguish between a bad and a doubtful debt. A debt owing to a business that is not expected to be paid is a bad debt. A doubtful debt is a debt, which the business considers may not be paid. The distinction is important because the accounting treatment differs, as shown below.