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Identify and Write Off Bad Debts

When preparing our accounts we have a duty to compile them in a manner that means they are correct to the best of our knowledge and belief, and any changes to the circumstances of the business that will result in an amendment being needed must be posted correctly so the accounts do adequately reflect our business transactions.


When we make a sale of goods or services to our customers and the customer does not pay immediately and we offer them credit then our bookkeeping transaction for the sale is a credit to our sales account and debit our debtors account. Because to increase sales we post a credit and to increase debtors we post a debit.


This results in an increase in our sales account (which is income on the profit and loss account) and increase to our debtors (which is a current asset on our balance sheet). Once we know that our customer is not going to pay the debt we must write this transaction off otherwise we would overstate our business profits and consequently pay too much tax, in addition our balance sheet would not reflect the current situation in the business and we would be artificially increasing the assets on the balance sheet.


This is an area of bookkeeping I find that many business owners simply do not understand.


In order to write these off most people would simply reverse the transactions that were originally posted so they would post a credit to the sales account and post a debit to the debtors account to record the sale and then they would reverse this by posting a debit to the sales account and posting a credit to the debtors account, this would reduce the profit to the correct amount and also reduce the debtors(but it would still leave the sales overstated in the accounts so to correctly post this transactions we would post a debit to the bad debt write off account which is an expense in our profit and loss account and post a credit our debtors account.


Doing it this way our sales remain unchanged (remember the sale was made and the goods or services were not returned, it was just never paid for) but the expenses increase by the amount of this sale as a bad debt write-off, which in turn makes our profit correct. The Credit to debtors balances out the previous debit to debtors that we posted when the client made the purchase.