Writing off Accounts Receivable is done when a client is unable to pay the money they owe us. This often happens when a client goes bankrupt.
There are two methods used when writing off bad debt. The direct write off method or the bad debt provision method.
When writing off accounts receivable there are two methods that are usually used.
Directly Writing Off Accounts Receivable
A direct write off is when you directly credit a particular client in Accounts Receivable.
Burger Company have gone bankrupt and owed us $15,000. Under the direct write off method our journal entry would be:
|Debit Bad Debts Expenses (Income Statement)||$15,000|
|Credit Accounts Receivable||$15,000|
This would lower the value of your Accounts Receivable by $15,000 and add a $15,000 expense onto the profit and loss account.
Bad Debt Provisions
Most companies know that during the year they are likely to not receive payment from a percentage of clients. Depending on the industry and the clients, this percentage can be very low or fairly high.
It’s normal for a business to create a bad debt provision.
As an example, Shoe Company on average does not receive payment for 5% of the sales on their Accounts Receivable.
The accountant will create a bad debt provision, which is like an accrual for clients not paying.
Shoe Company has $100,000 on their accounts receivable. The accountant would do the following with a 5% bad debt provision.
|Debit Bad Debts Expenses||$5,000|
|Credit Bad Debt Provision (this would sit on the balance sheet like an accrual)||$5,000|
Running Company has gone bankrupt and is unable to pay Shoe Company the $1,000 they owe them. The Show Company finance team would credit accounts receivable and debit the bad debt provision.
|Credit Accounts Receivable||$1,000|
|Debit Bad Debt Provision||$1,000|
This would make Accounts Receivable now worth $99,000 and the Bad Debt Provision would have a value of $4,000. We would still have $5,000 on the income statement for bad debt.