When a business sells goods or services on credit terms it runs the risk that the customer will not pay some, or all, of the amounts charged. This might be because:
- The customer has become bankrupt or has gone into liquidation
- The customer has disappeared
- The cost of collecting the debt makes it uneconomic to do so
Whilst a business will try to collect all the money it is owed from its customers, sometimes they have to admit that there is no realistic prospect that a particular debt will be paid. In these circumstances the business will record an irrecoverable debt journal (also known as a bad debt journal).
Recording an irrecoverable debt
A bookkeeper will first calculate the amount to written off as irrecoverable or bad. This might be the whole amount due from a customer or might just be a portion of the total.
Record a journal as follows:
- The total (i.e. VAT inclusive) amount of the debt that is being written off will be credited to the Sales Ledger Control Account. [Note that this amount will also be recorded on the credit side of the customer account in the Sales Ledger]
- The VAT included in the total amount of debt to be written off will be debited to the VAT account.
- The net amount included in the total amount of debt to be written off will be debited to the Irrecoverable Debts account (alternatively called the Bad Debts account)
Lydia is owed £6,000 from a customer, Bowling Ltd and has discovered that the company has gone bust and she will receive none of the outstanding amount. Lydia charges VAT at the standard rate of 20% on all her sales.
- The total to be written off as irrecoverable is £6,000 of which £1,000 (i.e. 1/6th) is VAT and £5,000 is the net debt being written off.
- The journal to be posted is as follows:
The above journal would be recorded in the General Ledger accounts as shown below
It would also appear in the Bowling Ltd account in the Sales Ledger as follows:
Partial write-off of a customer account
Sometimes we might expect to collect only part of a customer’s debt, in which case we will write off the remainder as irrecoverable. For example, let’s say a business is owed £1,200 from a customer that has gone into liquidation and the liquidator informs us that we are likely to receive forty pence in the pound (i.e. we will receive 40% of the debt). This means that sixty pence in the pound (i.e. 60%) of the debt has gone bad and should be recorded as irrecoverable. The journal to record the irrecoverable debt would be as follows
Receipt of money from a debt that was written off
Occasionally, after a debt has been written off as irrecoverable, a business might receive payment from a customer. Perhaps, the customer has reappeared or their finances were not as bad as was originally feared.
Where this happens we will record the receipt of the money as normal, that is, we will record it in the Cash Book in the Trade Receivables (or Sales Ledger) column but we will then have to record a journal to reverse all or part of the irrecoverable debt journal that was originally posted.
Keith makes a sale to Dueby Ltd for £1,200 (including VAT at 20%). Dueby Ltd then went into liquidation and Keith wrote the whole of the debt off as being irrecoverable using the following journal
A little later, Keith received £900 from Dueby Ltd’s liquidators. This was recorded as normal so £900 was debited to the Bank account and credited to the Sales Ledger Control account.
A part reversal of the above journal would be required as if nothing else is done, Dueby Ltd’s sales ledger account would show that they had overpaid by £900. The journal would be as follows
If we look at the General Ledger accounts the entries would be:
Dueby Ltd’s customer account in the Sales ledger would be: