Bad debts, Doubtful

debts, and
payment discounts
Introduction to Bad Debts
• Many businesses sell on credit terms, so there is always a risk that
some customers might not pay for the goods and services they have
received.
• The cost of these ‘bad debts’ is therefore a regular expense for many
businesses.
• When a business realises that it is highly unlikely to ever receive a
certain amount due from a particular customer, the debt must be
removed from the records.
• The debt is said to be bad or irrecoverable and must be written off.
Introduction to Bad Debts
• To write off a bad debt, the customer’s account will be credited in order to
remove the asset from the books and the bad debts expense account will
be debited to record the cost of this to the business.
• To record a bad debt, you credit the debtor's account to cancel the asset
and increase the expense account by debiting it to the bad debts account.
• Journal Entry for Bad Debt
Bad Debt Expense Dr
Account Receivables Cr
• Bad debts expense in income statement alongside all her other expenses
such as wages, rent, electricity, and so on.
Introduction to Bad Debts
• There is a range of possible scenarios that may exist concerning a bad
debt.
• the debtor may be refusing to pay one of a number of invoices;
• the debtor may be refusing to pay part of an invoice;
• the debtor may owe payment on a number of invoices and have
indicated that only a proportion of the total amount due will ever be
paid because the debtor's business has failed;
• the debtor's business has failed and nothing is ever likely to be
received.
Example for Bad Debts
• At the end of its financial year ending 31 December 2024, Sue’s
business has trade receivables totaling £52,000. Of these, it is
discovered that C. Smith (who bought goods from Sue for £1,300 on
23 October and has not paid) has been declared bankrupt and T.
Jones (who bought goods for £600 on 17 September and has not
paid) has disappeared without trace. These are the only two
irrecoverable debts Sue has identified this year.
Allowance for Doubtful debts
• You’ve seen that specific amounts due from customers that are
believed (with reasonable certainty) to be uncollectable must be
written off. They will be removed from the records and the business
will essentially give up on any attempt to chase the money.
• However, it is unlikely that the business will be able to identify all the
specific debts that won’t be collected. Amounts are only written off
when the business is fairly certain that the money will not be
received, and there will be other amounts over which there is merely
doubt.
Allowance for Doubtful debts
These doubtful debts arise for a combination of two reasons:
• The business may be worried about particular debts due from certain
customers. It may believe that there is still some chance of collecting
the money, but there is definitely cause for concern. The business is
not ready to give up on these debts and write them off yet.
• The business may have debts due from hundreds of different
customers and cannot predict exactly which ones won’t be collected.
However, it knows from experience that a certain proportion of them
will not be paid.
Allowance for Doubtful debts
• Businesses often use a report commonly known as an Aged Debtors
Report to help establish the size of the allowance.
• This report lists all the business’s customers, how much they owe and
how long the business has been waiting for the money.
• The business can review the report to identify specific amounts over
which there is doubt and also apply percentages derived from
experience to estimate the proportion of debts that may not be
recovered.
Allowance for Doubtful debts
• When a business sets up an allowance for doubtful debts for the first
time, the entire allowance will be entered in the accounts as follows:
Debit Profit and Loss Account £x
Credit Allowance for doubtful debts £x
• The allowance for doubtful debts account is credited because it will
ultimately be offset against the figure for trade receivables in the
balance sheet.
Allowance for Doubtful debts Example
• At his financial year end of 31 December 2024, J. Bakir’s trade
receivables were £40,000. This was after writing off bad debts of
£5,400 during the year. For the first time, Bakir carefully analysed his
business’s experience with bad debts. The evidence indicated that 3%
of his outstanding trade receivables are unlikely to be collected. Bakir
has never set up an allowance for doubtful debts before.
Increasing the allowance for doubtful debts
At the end of their financial year, businesses must assess what allowance for
doubtful debts is needed. If the business already has an allowance for
doubtful debts in its books, then the existing allowance simply needs to be
adjusted to the new figure. If the allowance needs to be increased:
• The allowance for doubtful debts account must be credited with the
amount of the increase. It is a credit entry because the business is
increasing the amount that will ultimately be offset against the asset of
trade receivables in the balance sheet.
• The profit and loss account must be debited with the amount of the
increase in the allowance. This is logical because the business is recognizing
that the value of trade receivables over which there is doubt has risen; this
‘bad news’ is an extra business expense and is therefore a debit entry.
Increasing the allowance for doubtful debts
• On 31 December 2025, J. Bakir’s trade receivables were £50,000. This
was after writing off bad debts of £5,600 during the year. Once again
Bakir carefully analysed his business’s experience with debt collection.
The evidence continued to indicate that 3% of his outstanding trade
receivables are unlikely to be recovered.
Reducing the allowance for doubtful debts
• Sometimes a business will assess what allowance for doubtful debts is
needed and find that it is lower than the allowance that already
exists. If the allowance needs to be reduced:
• The allowance for doubtful debts account must be debited with the
amount of the reduction.
• The profit and loss account must be credited with the amount of the
reduction. This is logical, because the business is essentially
recognising that the value of trade receivables over which there is
doubt has fallen.
• This ‘good news’ is reflected with a reduction in the expense of bad
debts, which requires a credit entry.
Reducing the allowance for doubtful debts
• Journal Entry for this reduction
Debit Allowance for doubtful debts
Credit Profit and Loss
Reducing the allowance for doubtful debts
• On 31 December 2026, J. Bakir’s trade receivables were £44,000. This
was after writing off bad debts of £6,300 during the year. Once again
Bakir analysed his business’s experience with bad debts and the
evidence continued to indicate that 3% of his outstanding trade
receivables are unlikely to be collected.
Bad Debts Recovered
• Sometimes, a debt written-off in previous years is recovered. When this
happens, you:
• Reinstate the debt by making the following entries:
Dr Debtor's account
Cr Bad debts recovered account
• When payment is received from the debtor in settlement of all or part of
the debt:
Dr Cash/bank
Cr Debtor's account
with the amount received.
Allowances for prompt payment discounts on
receivables
• Businesses sometimes offer prompt payment discounts to their customers
to encourage them to pay quickly.
• There different ways to recognize the discount allowed and its allowance
for prompt payments
• When a sale is made on credit terms and a prompt payment discount is
offered, we’ll assume that the discount is unlikely to be taken and simply
record the sale at full price. For example, suppose a business sells goods on
credit terms to the value of £100 to P Johnson and offers a prompt
payment discount of 3%. The double entry impact will be
Debit P Johnson receivable £100
Credit Sales £100
Allowances for prompt payment discounts on
receivables
• If Johnson does pay quickly and takes the 3% prompt payment
discount, then the debt will be cleared and the discounts allowed
account will be debited:
Debit Cash at bank £97
Debit Discounts allowed £3
Credit P Johnson receivable £100
Allowances for prompt payment discounts on
receivables
• In the income statement, the balance on the discounts allowed account will
be deducted from the figure for sales revenue in order to reflect the actual
amount earned from sales.
• At the end of the year, all amounts due from customers can be reviewed.
The business can use its past experience to estimate which debts are likely
to be paid early and will therefore be received net of prompt payment
discounts.
• An allowance can then be set up for the total value of prompt payment
discounts that are likely to be taken in relation to trade receivables as at the
year end:
Debit Profit and Loss £x
Credit Allowance for prompt payment discounts £x