Meaning and Treatment of Bad and Doubtful Debts

While preparing the financial statements, you will frequently reference bad and doubtful debts. Both these accounts are charges against the profit.

However, they are not the same. Hence, it is essential to ensure you understand the difference between bad debts and doubtful debts.

It is a commonly accepted accounting principle that debts which are considered bad, or doubtful should be written off as soon as possible. However, many businesses choose to delay this process, hoping the debtor will eventually pay. This can lead to problems down the line, as the business may find it difficult to reclaim the money owed to them.

What are Bad Debts?

A business or individual is said to incur bad debt when money owed to them will most likely never be paid back, often due to the incapacity or unwillingness of the debtor to pay.

When collection attempts are unsuccessful, they are usually regarded as a financial loss and impact the business as an expense on its financial statements. To illustrate, when a customer does not pay an invoice of $1,000 and all recovery attempts are deemed futile, the invoice gets classified as bad debt.

Accounting Treatment of Bad Debts

There are moments when it’s obvious, without a doubt, that the customer will not settle their payment. In their storefront went out, or they have simply vanished. In such a scenario, you will write off such an amount as a loss or expense.

Consider the case where you extended credit to Ramesh for goods amounting to ₹10,000. Ramesh is your debtor which means that Ramesh appears in your Balance Sheet as a Debtor. You later discover that Ramesh is unable to pay a portion of this amount, say ₹2,000. Now, this amount of ₹2,000 is deemed a bad debt.

Date	Particulars	Amount (Dr)	Amount (Dr)
31-3-2025	Bad Debts Ac/ Dr	₹2,000
	To Ramesh A/c		₹2,000

Here, Bad Debts A/c is debited as this a loss (debit all losses) in the same manner as an expense is. It will go to the Profit and Loss Account and consequently reduces your profit (or gives a loss in your business).

Ramesh A/C is credited as this diminishes the unpaid amount that Ramesh has with you in the Debtors account, thus enabling your Balance Sheet to exhibit less Debtors.

What are Doubtful Debts?

In addition to bad debts, you may also be required to account for doubtful debts. In practice, businesses have learnt from experience that some debtors will not pay – but they are not certain which debtors this applies to at the end of the year.

Businesses have to make a judgement on what proportion of debtors might not pay. For example, some businesses operate in sectors of the economy that carry a higher risk of failure than other sectors of the economy.

It is worth noting that doubtful debts have nothing to do directly with debtors’ accounts. This account is opened by debiting the profit and loss account. Simply, it is a provision like other provision accounts.

It might be prudent to assume that a relatively high proportion of debtors should be classified as ‘doubtful’ in the catering or building sectors. In contrast, businesses with debtors in a much safer and less risky sector – such as in the government sector – might need to classify a smaller proportion as ‘doubtful’. 

Accounting Treatment of Doubtful Debts

Creating a Provision for Doubtful Debts follows the conservatism or prudence principle of accounting. This principle says that:

“Anticipate all possible losses, but not profits.”

So, the business assumes some debts might become bad and makes an estimated adjustment.

1. Creating the Provision (at the end of the year):

Suppose total debtors = ₹50,000
You expect 5% may not be recovered
So, provision = 5% of ₹50,000 = ₹2,500

Date	Particulars	Amount (Dr)	Amount (Cr)
31-03-2025	Profit and Loss A/c	₹2,500
	To Provision for Doubtful Debts A/c		₹2,500

2. How Is It Shown in the Final Accounts?

In the Profit and Loss Account:

• Provision for doubtful debts is shown on the debit side (as an expense).

In the Balance Sheet:

• Show total debtors minus provision under Current Assets.

Example:
Debtors = ₹50,000
Less: Provision = ₹2,500
Net Debtors = ₹47,500

Conclusion

There are many reasons why debt may be classified as bad or doubtful. The most common reason is that the debtor has failed to make any payments for a period of time. This could be because they are experiencing financial difficulty, or simply because they are trying to avoid paying the debt. Either way, it is important to act quickly in order to maximise the chances of getting the money back.

Another reason why debt may be considered bad is if the debtor is contesting the debt. This could be because they dispute the amount that is owed, or they may not believe that they owe the debt at all. In these cases, it is again important to act quickly in order to get a ruling from the courts.

Once a debt has been classified as bad or doubtful, the next step is to write it off. This means that the debt is no longer considered an asset of the company, and the company will not attempt to collect the debt. This can have a significant impact on the company’s financial statements, so it is important to consult with an accountant before taking this step.