How to Deal With Bad Debt
Not everyone is able to pay up when the invoices arrive. Most often it’s just financial bad luck. Sometimes the customer has gone bankrupt, or the debt has in some other way become worthless or impossible to collect. Whatever the case may be, it’s necessary for every small business to take into account the occasional unpaid bill. So how should you handle bookkeeping for bad debt? Let’s take a look.
Estimates, Credits, and Debits
One of the essential principles of financial planning is to prepare for adverse possibilities.
That means it’s important to be aware of your company’s history of issues with customers’ bad debts. Bookkeeping for bad debt requires that you take a look at your past records and make a provision for similar amounts of bad debt going forward.
Appropriately enough, we call this method of accounting the Provision Method, or also the Allowance Method. There is an alternative method called Direct Write-Off. In that method, which businesses use for tax reasons, you write off the bad debts as soon as they become uncollectible.
The provision/allowance method, on the other hand, makes it easier to understand the real value of your assets and liabilities. Even though you’ll inevitably have to make adjustments in the final ledgers, it recognizes that some losses are also inevitable, and helps you plan accordingly.
Although it seems complex, it helps you avoid making business decisions based on over-optimistic assumptions.
Bookkeeping for Bad Debt Can Be Easy
The procedures surrounding bookkeeping for bad debt are a standard part of the Generally-Accepted Accounting Principles (GAAP).
Since under GAAP, you record income and expenses at the moment of the transaction, not the moment of payment, it’s a question of applying credits and debits to Accounts Receivable and associated accounts.
“…an allowance for credit losses is established based on an anticipated and estimated figure. A company will debit bad debts expense and credit this allowance. The allowance for doubtful accounts is a contra account within accounts receivable, which means that it reduces the loan receivable account when both balances are listed in the balance sheet. This allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.” — Investopedia
Now, we admit that’s a mouthful, after all. If you aren’t an accountant or bookkeeper yourself, you may not be so comfortable handling these procedures. That’s why SyncLedgers exists. We also come with the added benefit that our services are far more cost-effective than hiring an in-house specialist. Contact us today and stop worrying about your money management!