Bad Debts

No
business wants bad debts but when customers pay for goods or services after
supply then some bad debts are inevitable.

There
are a few measures to reduce these and good credit management and frequent
statements are some of the most effective. You can assist your clients with
this because if you’re doing weekly or monthly work you should have the
information on what is owed to your client and again it’s one of the areas you
should proactively be monitoring to assist your client.

When
they do occur the sale is recorded in the accounts and you need to post an
entry to ensure the profit isn’t overstated (too high) also you need to remove
it from the debtors.

The
original accounts we need to look at are

Mr
Anybody purchased goods to the value of £500 from you and the original
sales were entered like this

We
credited the Income/Sales Account and debited the Customers – Mr Anybody
account. However, the debt is now not going to get repaid so we need to write it
off

This
is how the entries should look

The
effect of this is to raise a credit to the customers – Mr anybody account to
balance off the debit that will now not be paid and post a debit to the
expenses – Bad debt account.

WE
CANNOT just simply reverse the sale as this was a genuine sale but became a bad
debt. Reversing the sale would understate our sales and could result in issues
with VAT registration. Posting a debit as an expense will give the same profit
as simply reversing the sale but will make the accounting correct.

This
is how the final accounts would look showing the carried forward and brought
forward balances

So when should we write
off a bad debt?

As
soon as it become apparent the debt is unlikely to be repaid, our accounts
should reflect the true statement of affairs for a business and writing off
debts too early will artificially lower profits, whilst keeping bad debts on
the accounts for too long will artificially raise profits. We as bookkeepers
have a duty to help our client keep accurate records in line with reporting
standards.

It’s
always a grey area when the debt turns bad and there may be some scope for
waiting a bit longer or writing it off before the year end but we should be
prudent in not advising our clients wrongly.

 

If
the client is VAT registered there may be VAT to reclaim depending on whether
the client is on the Standard VAT Scheme or Cash Accounting.
 

But
for this module we need to know the VAT entries on our bookkeeping, so if the
client was VAT registered then the entries would be

This
is because if the client was VAT registered the sale would have been recorded
NET of VAT and so the recording of our bad debt needs to be NET of VAT.

What happens if after we
have written off a bad debt it gets paid?

The
correct treatment of this would be (assuming the money is paid straight into the business
bank account and assuming the client is VAT registered)

In
reality a lot of people would simply raise a new invoice but this would
overstate sales (if the client is not VAT registered and you raise another
invoice you would add £2000 to your clients sales and this could put them over
the VAT threshold meaning they would need to register for VAT unnecessarily).

 This video shows the double entry bookkeeping transcations when you are dealing with bad debts

Menu Title