Bad debts and the allowance for doubtful debts
Write off debts that cannot be collected, then keep an allowance for doubtful debts so receivables are not overstated. Only the change in the allowance affects profit.
Bad and doubtful debts
When a credit customer cannot pay (for example, the shop has closed), the debt is bad and is written off: Dr Bad debts, Cr Trade receivables. Other debts are doubtful: they may not be collected. Under prudence and the accrual concept, the business estimates them and keeps an allowance for doubtful debts (older books call it a provision). The full allowance is deducted from receivables in the statement of financial position, but only the increase or decrease in it each year goes to the income statement.
Worked example 1: write-off and a larger allowance
At 31 March 2026 trade receivables are Rs. 860,000. A debt of Rs. 20,000 is to be written off. The allowance is to be 5% of the remaining receivables. The existing allowance is Rs. 30,000.
- Receivables after the write-off: 860,000 − 20,000 = 840,000.
- Required allowance: 5% × 840,000 = 42,000.
- Increase needed: 42,000 − 30,000 = 12,000.
- Entries: Dr Bad debts 20,000, Cr Trade receivables 20,000; Dr Doubtful debts expense 12,000, Cr Allowance for doubtful debts 12,000.
- Income statement charge: 20,000 + 12,000 = 32,000.
- SFP: receivables 840,000 − allowance 42,000 = 798,000.
Charge to profit Rs. 32,000; receivables shown at Rs. 798,000 net.
Worked example 2: the allowance goes down
A year later receivables are Rs. 700,000, there are no bad debts, and the allowance stays at 5%. The opening allowance is Rs. 42,000.
- Required allowance: 5% × 700,000 = 35,000.
- Decrease: 42,000 − 35,000 = 7,000.
- Entry: Dr Allowance for doubtful debts 7,000; Cr Income statement (reduction in allowance) 7,000.
- SFP: 700,000 − 35,000 = 665,000.
The decrease of Rs. 7,000 is added to profit; receivables are shown at Rs. 665,000.
Worked example 3: a bad debt recovered
A debt of Rs. 15,000 written off last year is unexpectedly paid in cash.
- Reinstate the debt: Dr Trade receivables 15,000; Cr Bad debts recovered 15,000.
- Record the cash: Dr Cash 15,000; Cr Trade receivables 15,000.
Bad debts recovered, Rs. 15,000, is shown as income. Reinstating first keeps a record that the customer paid.
Where each item goes
| Item | Income statement | Statement of financial position |
|---|---|---|
| Bad debt written off | Expense | Reduces trade receivables |
| Increase in allowance | Expense | Larger deduction from receivables |
| Decrease in allowance | Income (or a reduced expense) | Smaller deduction from receivables |
| Bad debt recovered | Income | No balance left once the cash is received |
Sri Lankan banks and finance companies keep large impairment allowances for loans that borrowers may not repay. A small wholesaler selling on credit to village boutiques faces the same risk on a smaller scale.
Short answer: “Distinguish a bad debt from a doubtful debt.” A bad debt will not be collected and is written off; a doubtful debt may not be collected and is covered by an allowance.
Structured question: “Calculate the bad debts charge and the net receivables from the given data, and show the entries.” Write off bad debts, compute the new allowance, find the increase or decrease, then show the income statement charge and the net receivables.
Only the change in the allowance goes to the income statement. The full allowance is deducted from receivables in the SFP. Write off bad debts before calculating the allowance.