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Lesson 10 — Bad Debts and Provision for Doubtful Debts

Writing Off Bad Debts, Recovery of Bad Debts & Provision for Doubtful Debts | Cambridge O Level Accounting 7707

📘 Lesson 10 of 16
63% complete
📌 Prerequisites: You should understand trade receivables (debtors), how the Sales Ledger works, and the concept of prudence in accounting before starting this lesson.

1. Bad Debts — Writing Off 7707 / 3.7

When a business sells goods on credit, it creates a trade receivable (debtor). Most debtors pay — but occasionally a customer cannot or will not pay. When it becomes clear that a debt will never be recovered, it must be removed from the books as a bad debt.

Bad Debt: A debt that is irrecoverable and must be written off as an expense in the Income Statement. The debtor's account is closed and the amount is charged as a loss to the business.

Why Bad Debts Arise

Double Entry for Writing Off a Bad Debt

Writing Off a Bad Debt

DR   Bad Debts Expense Account         (Income Statement — expense) CR   Individual Debtor's Account         (Sales Ledger — remove the debt)
📌 Note: Writing off a bad debt also reduces the Sales Ledger Control Account on the credit side — consistent with what we covered in Lesson 6.

Worked Example — Writing Off a Bad Debt

📋 Example 1: Bad Debt Written Off

On 30 November 2026, it is confirmed that a debt of $650 owed by customer Tariq cannot be recovered. Write off the bad debt.

Individual Debtor Account — Tariq

Bad Debts Expense Account

Effect: Tariq's account is now nil — the debt is removed. The $650 is charged to the Income Statement as an expense (bad debts), reducing profit. Trade receivables in the Statement of Financial Position are also reduced by $650.

2. Recovery of a Bad Debt Previously Written Off

Occasionally, a debt that was written off in a previous period is unexpectedly recovered — the customer pays after all. This requires two entries: first reinstate the debtor, then record the cash receipt.

Recovery of a Bad Debt — Two Steps

Step 1 — Reinstate:   DR Debtor's Account              CR Bad Debts Recovered Account Step 2 — Cash receipt: DR Bank / Cash                CR Debtor's Account
💡 Why reinstate first? The debtor's account was reduced to zero when the debt was written off. Before cash can be credited against it, the account must be brought back to show the amount owed — otherwise the debtor's account would go into credit, which makes no sense.
📌 Income Statement Treatment: The Bad Debts Recovered account is transferred to the Income Statement as other income (it increases profit). It is not used to reduce the bad debts expense account.

Worked Example — Recovery

📋 Example 2: Tariq's debt of $650 (written off in 2026) is recovered in March 2027

Bad Debts Recovered Account (2027)

3. Provision for Doubtful Debts Exam Focus

A bad debt is written off when a specific debt is confirmed as irrecoverable. But what about debts that are uncertain — where there is doubt about recovery but no certainty yet? The prudence concept requires that we anticipate possible losses before they are confirmed.

Provision for Doubtful Debts (PDD): An estimated amount set aside from profit to cover debts that might not be collected. It is based on past experience or a percentage of trade receivables. It does not remove any specific debtor from the ledger — it simply reduces the net value of receivables shown in the SFP.

Bad Debts vs Provision for Doubtful Debts

Feature Bad Debt Written Off Provision for Doubtful Debts
Certainty Certain — debt confirmed irrecoverable Uncertain — estimated possible loss
Effect on debtor's account Debtor's account is closed (zeroed) Debtor's account remains unchanged
I/S treatment Expense: Bad Debts Expense: Increase in provision
Income: Decrease in provision
SFP treatment Reduces trade receivables directly Deducted from trade receivables as a contra
Accounting principle Accruals / Matching Prudence
📌 Important: The PDD is calculated on the remaining trade receivables after bad debts have already been written off. Always write off bad debts first, then calculate the provision on the adjusted receivables balance.

4. Creating, Increasing and Decreasing the Provision

The Provision for Doubtful Debts account is a credit balance account (like accumulated depreciation — it is a contra asset). Each year end, the provision is compared with the required amount and adjusted accordingly.

Calculate required
provision this year
→
Compare with
existing provision
→
If higher:
Increase provision
→
If lower:
Decrease provision

Double Entry — Three Scenarios

Scenario A: Creating a Provision for the First Time

DR   Bad Debts Expense / Irrecoverable Debts Expense    CR   Provision for Doubtful Debts A/c

Scenario B: Increasing an Existing Provision

DR   Bad Debts Expense (the increase only)           CR   Provision for Doubtful Debts A/c

Scenario C: Decreasing an Existing Provision

DR   Provision for Doubtful Debts A/c               CR   Bad Debts Expense (reduction in provision)
💡 I/S Rule: Only the change in provision goes to the Income Statement — not the full provision balance. An increase is an expense (reduces profit); a decrease is income (increases profit). The full provision balance is shown in the SFP.

5. Multi-Year Worked Example Exam Focus

📋 Example 3: Three Years of Provision Adjustments

The following information is available for Nadia Traders:

Year End Trade Receivables ($) Bad Debts Written Off ($) PDD Required
31 Dec 202440,000 (after bad debts)8005% of receivables
31 Dec 202550,000 (after bad debts)1,2005% of receivables
31 Dec 202635,000 (after bad debts)6005% of receivables

Step 1 — Calculate required provision each year:

Year Receivables ($) Rate Required Provision ($) Existing Provision ($) Change ($) I/S Treatment
202440,0005%2,000Nil (first time)+2,000Expense: $2,000
202550,0005%2,5002,000+500Expense: $500
202635,0005%1,7502,500−750Income: $750

Step 2 — Provision for Doubtful Debts Account (all three years)

Key point: The Provision for Doubtful Debts account always has a credit balance. Each year the balance is adjusted: an increase → credit the account; a decrease → debit the account. Only the change goes to the Income Statement.

6. Presentation in the Statement of Financial Position

In the Statement of Financial Position, the Provision for Doubtful Debts is shown as a deduction from Trade Receivables — just as accumulated depreciation is deducted from the cost of a non-current asset.

Extract from Statement of Financial Position — 31 Dec 2025
Current Assets
Trade Receivables50,000
Less: Provision for Doubtful Debts(2,500)
Net Trade Receivables47,500
Extract from Statement of Financial Position — 31 Dec 2026
Current Assets
Trade Receivables35,000
Less: Provision for Doubtful Debts(1,750)
Net Trade Receivables33,250
💡 Examiner Tip: In the SFP, always show the gross trade receivables and the provision separately — never just the net figure. Examiners award marks for correct layout and labelling.

7. How Everything Appears in the Income Statement

The Income Statement typically shows bad debts and provision changes together. Using the figures from Example 3 above (year 2025):

Item$
Bad debts written off (2025)1,200
Increase in provision for doubtful debts (2025)500
Total charge to Income Statement (2025)1,700

And for 2026 (when provision decreased):

Item$
Bad debts written off (2026)600
Decrease in provision for doubtful debts (2026) — income(750)
Net charge to Income Statement (2026)(150) net income
📌 Note: When the decrease in provision exceeds the bad debts written off, the net effect is a credit to the Income Statement (increases profit). This is unusual but perfectly valid accounting — always present the items separately and let the net figure speak for itself.

8. Memory Aids & Common Mistakes

🧠 Memory Aid — PDD vs Bad Debt

Bad debt = certain loss → write off completely → debtor account zeroed
Provision = possible loss → estimate set aside → debtor account untouched

🧠 Memory Aid — I/S vs SFP for Provision

I/S gets the change (increase = expense, decrease = income)
SFP gets the full balance (deducted from trade receivables)

⚠️ Mistake 1 — Charging the full provision to I/S every year: Only the change in provision goes to the Income Statement. Charging the full provision balance as an expense every year is a very common and serious error.
⚠️ Mistake 2 — Calculating the provision on the wrong receivables figure: Always write off bad debts first, then calculate the provision on the remaining receivables. Calculating on the gross figure (before writing off) overstates the provision.
⚠️ Mistake 3 — Treating a decrease in provision as an expense: When the provision decreases, it is a credit to the Income Statement (income / reduction in expense) — not a further expense. Debit the provision account and credit the I/S.
⚠️ Mistake 4 — Showing only net receivables in the SFP: Always show gross trade receivables and the provision as a separate deduction. Never just show the net figure on its own — the examiner requires the full layout.
⚠️ Mistake 5 — Forgetting bad debts reduce the SLCA: When a bad debt is written off, the Sales Ledger Control Account must also be credited. Bad debts written off appear on the credit side of the SLCA (just as we saw in Lesson 6).

📝 Exam Practice Questions

Question 1 Knowledge — 2 marks

Explain the difference between a bad debt and a provision for doubtful debts.

A bad debt is a specific debt that is certain to be irrecoverable — it is written off and the debtor's account is closed to nil. (1 mark)

A provision for doubtful debts is an estimate of debts that may not be recovered — it is based on prudence and does not remove any specific debtor from the ledger. It reduces the net value of trade receivables in the SFP. (1 mark)

Question 2 Application — 4 marks

At 31 December 2026, trade receivables are $60,000 before writing off bad debts. Bad debts to be written off total $2,000. The business maintains a provision for doubtful debts of 4% of trade receivables. The existing provision at 1 January 2026 was $2,100.

Calculate: (a) the provision required, (b) the change in provision, and (c) show how trade receivables appear in the SFP.

(a) Provision required:
Receivables after bad debts = 60,000 − 2,000 = $58,000
Provision = 58,000 × 4% = $2,320 (1 mark)

(b) Change in provision:
Required: $2,320  |  Existing: $2,100  |  Increase = 2,320 − 2,100 = $220 (expense) (1 mark)

(c) SFP Extract — 31 Dec 2026
Trade Receivables58,000
Less: Provision for Doubtful Debts(2,320)
Net Trade Receivables55,680

(2 marks for correct SFP layout with both figures shown)

Question 3 Application — 6 marks

Prepare the Provision for Doubtful Debts Account for three years using the following information:

Year EndTrade Receivables (after bad debts) ($)Provision Rate
31 Dec 202480,0003%
31 Dec 202590,0003%
31 Dec 202670,0003%

State the Income Statement charge or credit for each year.

Year Required ($) Existing ($) Change ($) I/S Effect
20242,400Nil+2,400Expense: 2,400
20252,7002,400+300Expense: 300
20262,1002,700−600Income: 600

Question 4 Application — 4 marks

A debt of $900 owed by customer Hamza was written off as a bad debt in the year ended 31 December 2025. In March 2026, Hamza unexpectedly pays the full amount of $900.

Prepare the ledger accounts to record the recovery of this bad debt in 2026.

📌 Two entries required: (1) reinstate Hamza's account, (2) record cash. The Bad Debts Recovered Account appears as other income in the 2026 Income Statement.

Question 5 Analysis — 5 marks

At 31 December 2026, the following information is available for Saad Enterprises:

  • Trade receivables before adjustments: $75,000
  • Bad debt to be written off: $3,000
  • Provision for doubtful debts at 1 January 2026: $3,600
  • Provision policy: 5% of trade receivables after bad debts

Calculate the total charge or credit to the Income Statement for bad debts and provision, and show the SFP extract at 31 December 2026.

Step 1: Receivables after bad debts = 75,000 − 3,000 = $72,000

Step 2: Required provision = 72,000 × 5% = $3,600

Step 3: Change in provision = 3,600 − 3,600 = $0 (no change)

I/S Item$
Bad debts written off3,000
Change in provision for doubtful debts0
Total charge to Income Statement3,000
SFP Extract — 31 Dec 2026
Trade Receivables72,000
Less: Provision for Doubtful Debts(3,600)
Net Trade Receivables68,400
📌 When the provision does not change, there is no I/S entry for provision — only the bad debt written off is charged. The provision balance in the SFP remains at $3,600.
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