No business concern wants to sell goods or services to a customer on credit basis who may prove unable or unwilling to pay his debts. Consequently, most business concerns have a credit department which makes investigation about the debts paying ability of each prospective customer. Regardless of how thoroughly the credit department investigates prospective customers, some bad debts will arise as a result of errors in judgments or because of unexpected developments. So, bad debts are caused by selling goods on credit to customers who .fail to pay their debts.
In these days most of the goods are usually bought and sold on credit. When a business sells goods to customers on credit basis, the customers become its debtors and the amount due from the debtors is called “Debts. For example, suppose, Rehman sold to Asif goods for Rs. 1,000 and to Qasim for Rs. 3,00 on credit. Here Asif and Qasim are debtors Of Rehman and debts due from them are Rs. 4000 (1000 + 3000).
1. BAD DEBTS:
The debts which are irrecoverable from the debtors (i.e. cannot be realized) are called Bad debts and the concerned debtors are called Bad debtors. In the above example, suppose, if Rehman fails to recover Rs. 1,000 from Asif, it will be a bad debt to Rehman and Asif will be regarded as bad debtor. It is undoubtedly a loss to Rehman, so in books of Rehman it must be recorded as a loss on account of bad debt.
It may be noted that in ledger of Rehman, Asif A/c has been closed as a result of recording bad debt in it. Before recording bad debt, Asif A/c showed a debit balance of Rs. 1,000 it means Asif was debtor (an asset) of Rehman. Now that amount has become bad, it can no longer be regarded as an asset. So Asif A/c has been written off by crediting it with Rs. 1000. To write off a debtor’s A/c it is to reduce the balance of debtor’s Ale to zero. On the other hand, bad debt is our loss, it will be transferred to the debit of P & L A/c at the year end.
Bad debt is a loss to the business; it arises out of credit sales. Hence bad debt can be avoided, if credit sales are discontinued and all the goods are sold in cash only. But in actual practice it is not possible to sell goods in cash only. Goods must be sold on credit — otherwise the business will stand still. Further profit on credit sales generally exceeds the loss arising on account of bad debts. That is why goods are sold on credit. There is no hard and fast rule for determining when a debt may become irrecoverable. The fact that a debtor fails to pay his debt on the due date in accordance with sales contract does not necessarily indicates uncollectibility. Generally, because of the following factors, a debt is regarded as bad:
Bankruptcy of the debtor
Disappearance of debtor’s business
Disappearance of the debtor
Failure of repeated attempt to collect the deb
2. DOUBTFUL DEBTS:
The debts, the recovery or realization of which is doubtful or uncertain are known as “Doubtful Debts”. It is an expected or possible loss to the business. So, it is necessary to estimate the loss to be suffered on account of doubtful debts and make a provision therefore by debiting P & L A/c at the year end. This is known as “Provision for Doubtful Debts”.
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