Credit Sales are a normal phenomenon in a business and with the credit sales, there are bound to be Debtors. Now the Debtors bring with them the component of risk factor of a debt going bad which eventually causes a loss for the business. That means that some debts will not be collected and will result in a loss to the business ( which we call as bad debts). However it is not possible for a business concern to classify all its book debts into either good or bad i.e debts which will certainly be realized and those that will certainly not be recovered. Hence there will be a number of border line cases in which there will be an element of doubt regarding the realization of the debts. Those book debts will be termed as Doubtful Debts.
Difference between Bad Debts and Doubtful Debts:
However similar they may sound, there is difference between bad and doubtful debts. The bad debts are those which are concluded to be irrecoverable after reasonable efforts have been made to realize them. On the other hand a doubtful debt may or may not be recovered. Thus a bad debt is considered as a known loss and is immediately written off in the books of accounts by crediting the customer’s account in the sales ledger whereas a doubtful debt is considered as an anticipated loss and is usually provided for in the books by creating a provision for doubtful debts. In the case of doubtful debts, the customer’s account in the sales ledger is kept intact. It is also worthy to mention that the amount of bad debts is written off as a loss and transferred to the Profit & Loss Account at the end of the accounting period. The amount is also reduced from the Debtors’ balance in the Balance Sheet. In case of doubtful debts, a provision is created by debiting the Profit and Loss Account so that the estimated loss relating to the current period (which can arise due to the doubtful debts becoming bad in future) is matched against the sales of the current period to which the debts are related. This results in proper matching of the bad debt losses against revenues. Provision for Doubtful debts is a contra account to the Debtors Account and is disclosed as a deduction from total debtors in the asset side of the Balance Sheet.