A Bad Debt means that someone who owed your business money (a Debtor) can no longer pay you.

EXAMPLE

Jenny Jones (a credit customer or debtor) owes your business £500as at the 1st January. On the 31st January you find out that she can no longer pay you. You decide to 'write off' this amount as a bad debt - in accordance with the Prudence Concept.

The accounting entries would be as follows:

Jenny Jones - Debtor

Bad Debt (an expense)

The Prudence Concept is being applied because the assets (which include debtors) should always be understated and ahve now of course been reduced. The impact on profit of an expense is of course to lower it (again applying the Prudence Concept which states that profits should not be overstated).

How is profit lowered?

The following double entry shows how a Bad Debt causes Profit to be understated at the end of the financial year (in this case - 31st December).

Bad Debt (an expense)

Profit and Loss Account

Profits or Losses = Revenues - Expenses.

For a given level of Revenues, any increase in Expenses will cause profits to fall.

EXAMPLE

Profits are £1,000, Revenues are £10,000 and Expenses are £9,000 - before the Bad debt is recorded.

£10,000 - £9,000 = £1,000

After the Bad Debt of £500 is processed we have:

£10,000 - £9,500 = £500

Profits have fallen!

What if the debtor was later able to pay the debt?

BAD DEBT RECOVERY (a level not gcse)