Bad Debts Journal Entry

Bad debts are losses to the business.

What’s the reason for losses?

Because debtors did not pay their dues.

So, these are unrecovered receivables.

Therefore, the entity needs to post a JE by

• Crediting the accounts receivable,
• Debiting them to a loss account.

Such a loss due to debtors is a bad debt.

Can there be recovery of bad debts?

Yes, it can happen.

In such cases, the entity prepares an entry.

But recorded to the extent of recovery.

Let’s see such a bad debt recovery JE.

Are you wondering why there will be any bad debt recovery? 

Here is an answer for you. Let’s consider an example of a “Failure” company having a receivable balance of $10,000 from a “Successful” Company in its books of accounts. Due to a fire accident at the Successful Company(the debtor), all the stocks at the Go-down and buildings were lost, so the successful company’s going concern is now a question mark. Per this accident, the Failure Company considers all the amounts due from the Successful Company as bad debts. 

However, the successful company had an insurance policy for losses and received almost 75% of its losses. So, it paid back the $7,500 of its due amount to the Failure company.

Read the Goods Lost by Fire article to understand the accounting in case of the loss of an asset.

Now, let’s understand how to record the entries relating to bad debt loss and recovery from bad debt in the books of accounts.

1) Bad Debts Journal Entry

Bad Debts are losses to the business and fall under Nominal accounts. All nominal accounts hit the statement of profit or loss. The accounting rule applicable to Nominal accounts is debiting all expenses or losses and crediting all incomes or gains. So, we will debit the bad debts GL.

Bad debts reduce the accounts receivable or sundry debtors’ balance. So, we need to cancel the accounts receivable GL with a debit balance and credit the receivable to nullify it.

2) Bad Debts Recovered Journal entry

The books of accounts do not comprise journal entries relating to Successful company transactions. The amount will be received by Cheque or Cash.

Also Read: True Up Journal Entry

General Approach

A bank or cash account is a real account. Per the Golden Rule of Accounting applicable to the Real Account, we must debit what comes in and credit what goes out. So, it’s clear that we need to debit the Bank account for the money received.

Due to the accident in this example, the receivable balance is considered bad debt, and the full amount is a loss. So, the extra amount received from such debtors is a bonus and is nothing but income. The credit will be the bad debt recovery GL (income account).

Alternative Approach

However, there is another accounting treatment for recording bad debt recovery. We can reverse the debtor and bad debts through a Journal entry to the extent of the collectible amount, which increases the debtor balance and reduces bad debt expense. Let’s see the Journal entry for those as well.

Also Read: Unbilled Accounts Receivable

1) Reversal of Debtors and Bad debts balance

2) Recording Bad Debts Recovered Journal entry

The above entries also produce almost the same output as the abovementioned approach. There is no correct or incorrect approach so that we can follow either of the two methods. 

Frequently Asked Questions

Are bad debts recovered as debit or credit?

Bad debts recovered are income to the entity and belong to the Nominal account. Per the Nominal account Golden rules of accounting(see above), bad debts recovered will be credited to the journal entry.

Can we call the bad debts recovered as revenue?

Yes, the recovered bad debts are revenue.

Also Read: Cash Coverage Ratio

What happens when bad debt is recovered?

We can record all uncollectible debts as bad debts. However, if there is any recovery from such a loss for any reason, then it’s an income. Therefore, we need to record such cash inflow as income to the entity.

How do you treat bad debts recovered in the Profit and Loss Account?

Considering its nature, we will treat bad debts recovered as income in the Profit and Loss account.

Bad debts recovered: Journal entry in the trial balance

In General, all Assets and Expenses will have a debit balance, and all Liabilities and incomes will have a credit balance. Therefore, Bad debts recovered GL being income will be on the credit side of the Trial balance.

Summary for Bad Debts Recovered Journal Entry

Bad debts recovered entry is to record the income receivable from already recorded bad debts. So, it’s a recovery from a lost asset. So, we will debit the bank account (asset account) and credit the bad debts recovery account (income account) in the journal entry.