When preparing our accounts we have a
duty to compile them in a manner that means they are correct to the
best of our knowledge and belief, and any changes to the
circumstances of the business that will result in an amendment being
needed must be posted correctly so the accounts do adequately reflect
our business transactions.
When we make a sale of goods or
services to our customers and the customer does not pay immediately
and we offer them credit then our bookkeeping transaction for the
sale is a credit to our sales account and debit our debtors account.
Because to increase sales we post a credit and to increase debtors we
post a debit.
This results in an increase in our
sales account (which is income on the profit and loss account) and
increase to our debtors (which is a current asset on our balance
sheet). Once we know that our customer is not going to pay the debt
we must write this transaction off otherwise we would overstate our
business profits and consequently pay too much tax, in addition our
balance sheet would not reflect the current situation in the business
and we would be artificially increasing the assets on the balance
This is an area of bookkeeping I find
that many business owners simply do not understand.
In order to write these off most people
would simply reverse the transactions that were originally posted so
they would post a credit to the sales account and post a debit to the
debtors account to record the sale and then they would reverse this
by posting a debit to the sales account and posting a credit to the
debtors account, this would reduce the profit to the correct amount
and also reduce the debtors(but it would still leave the sales
overstated in the accounts so to correctly post this transactions we
would post a debit to the bad debt write off account which is an
expense in our profit and loss account and post a credit our debtors
account. Doing it this way our sales remain unchanged (remember the
sale was made and the goods or services were not returned, it was
just never paid for) but the expenses increase by the amount of this
sale as a bad debt write-off, which in turn makes our profit correct.
The Credit to debtors balances out the previous debit to debtors that
we posted when the client made the purchase.