What is the difference between doubtful debts and bad debts

A credit sale is recorded by crediting the sales account and debiting the accounts receivable account. As the name suggests, a doubtful debt is an account receivable that is probably going to go unpaid. In simpler words, it is an account receivable that might become a bad debt at some point in the future.

As per the prudence concept of accounting, revenue shall only be recognized when it is certain whereas an expense shall be booked when it is probable more likely than not. Since the doubtful debt is of an uncertain amount and time, a provision or contra account must be created as per IAS This is called provision of doubtful debt and is treated as an operating expense as per the prudence concept. Such loss is treated as an operating expense and is referred to as a bad debt.

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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms Bad Debt Expense Definition Bad debt expense is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible. Allowance for Doubtful Accounts Definition An allowance for doubtful accounts is a contra-asset account that reduces the total receivables reported to reflect only the amounts expected to be paid.

A write-off primarily refers to a business accounting expense reported to account for unreceived payments or losses on assets. Contra Account Definition A contra account is an account used in a general ledger to reduce the value of a related account.

A contra account's natural balance is the opposite of the associated account. Partner Links. Related Articles. Accounting When are expenses and revenues counted in accrual accounting? Accounting When is revenue recognized under accrual accounting? Investopedia is part of the Dotdash publishing family.

Otherwise, your business may have an inaccurate picture of the amount of working capital that is available to it. Typically, businesses estimate their amount of bad debt based on historical experience. The provision for doubtful debt shows the total allowance for accounts receivable that can be written off, while the adjustment account records any changes that are made for this allowance.

You can do this via a journal entry that debits the provision for bad debts and credits the accounts receivable account. So, you can calculate the provision for bad debts as follows:. This means that the provision for doubtful debts needs to be increased. In your records, the adjusted allowance will look like this:. So, what happens when you need to increase the provision for losses on accounts receivable. This means that you need to adjust the provision for bad debts once again.

The journal entry for this adjustment will look like this:. So what if you only think they won't pay, meaning you haven't marked it off as bad debt yet? Here's where a provision for doubtful debt comes into play. Let's discuss the definition of doubtful debt, how you can plan for it, and how to use credit control for protection against bad debt.

Whereas bad debt is cash that you know a customer isn't going to pay, doubtful debt is cash that you predict will turn into bad debt. Whereas bad debt is cash that you know a client or customer isn't going to pay, doubtful debt is cash that you predict will turn into bad debt. Officially, it hasn't become bad debt yet — there's still a chance of reclaiming the lost money. You can use doubtful debt to limit your reported amount of accounts receivable, helping you create a more accurate picture of your company finances.

In theory, with doubtful debt being considered early, you'll know more realistically which debts will actually turn into cash and which may be written off. The Australian Taxation Office ATO does not allow deductions on the provision of doubtful debt, only truly uncollectible debt.

Doubtful debt is a provision — a prediction of future debt more so than a debt itself.