Bad Debts, Trade Receivables and Doubtful Debts – Definition, Example, General Journal Entry and their Difference:
A bad debt is a debt that is not recoverable after all efforts have been made for its collection. This may arise, for example, as a result of the insolvency or bankruptcy of a credit customer. A bad debt is treated as an expense in the income statement and reduces the value of trade receivables in the balance sheet. Following is the general journal entry for bad debts:
When a business sells goods to customers on credit, the customers become receivables of the business (trade receivables). This gives customers valuable ‘breathing space’, where they can pay for the goods at a time when they may have more money available. The business offering credit terms to its customers might not pay for the goods sold to them. Any trade receivable’s balance that remains unpaid after (a specified period of time has elapsed) is treated as a bad debt.
Clearly no one gives credit to customers, who are considered unreliable. But it may happen, though, that the receivables, who have been good customers in the past may find themselves in unforeseen difficulties. Customers sometimes become insolvent and cannot pay us and the do occasionally disappear without trace. Now a days all businesses need to extend credit to their customers . If they insist on “cash sale”, this may annoy many of these customers. This could be more vulnerable if the competitors are offering generous credit terms to these customers. In practice business selling goods on credit basis does not usually receive all of its sales revenue in cash as some of its customers are unable to pay up their debts.
A doubtful debt is a trade receivable where there is a possibility that he may eventually prove to be irrecoverable (bad debt). A doubtful debt is treated as an expense in the income statement. After recording doubtful debts, the amount of each individual trade receivable still remains the same.