Bad Debts vs Doubtful Debts: Difference and Comparison

Key Takeaways

1. Bad debts are a common financial issue that businesses encounter when customers fail to repay their outstanding debts.
2. Doubtful debts are an accounting concept that addresses the uncertainty surrounding the collectability of accounts receivable.
3. Bad debts are debts that are considered uncollectible and are written off as losses by the company. In contrast, doubtful debts are potentially uncollectible, but their status as losses is uncertain.

What are Bad Debts?

Bad debts are a common financial issue that businesses encounter when customers fail to repay their outstanding debts. These debts arise when a company extends credit to customers or clients and allows them to purchase goods or services on credit terms, expecting payment later. It represents a loss for the company and can significantly impact its financial wealth.

The process of recognizing bad debts involves several steps. Initially, businesses classify accounts receivable as assets on their balance sheets, representing the expected amount of money they anticipate collecting from customers.

Companies use various methods to calculate the allowance for bad debts, such as the percentage of credit sales method or the ageing of accounts receivable method. The chosen method depends on the company’s historical data and industry practices.

What are Doubtful Debts?

Doubtful debts, also known as provisions for doubtful debts or allowances, are an accounting concept that addresses the uncertainty surrounding the collectability of accounts receivable. These doubtful debts arise when a business is unsure whether specific customers will pay their outstanding debts in full or at all.

Dealing with doubtful debt begins when a business extends credit to its customers, creating accounts receivable. To account for the uncertainty of collection, companies estimate the portion of accounts receivable that is likely to be uncollectible.

It serves a crucial purpose in financial reporting, allowing businesses to address the uncertainty surrounding their accounts receivable prudently. By recognizing and accounting for doubtful debts, companies can assess their financial health more accurately and make informed decisions regarding credit policies, debt collection, and risk management.

Difference Between Bad Debts and Doubtful Debts

1. Bad debts are debts that are considered uncollectible and are written off as losses by the company. In contrast, doubtful debts are potentially uncollectible, but their status as losses is uncertain.
2. Bad debts are recognized as expenses immediately when it becomes clear they are uncollectible. At the same time, doubtful debts are initially identified as an allowance or provision for potential losses, with a specific amount set aside.
3. Bad debts reduce accounts receivable and directly impact the income statement. In contrast, doubtful debts are recorded as a contra-asset on the balance sheet, reducing the net value of accounts receivable.
4. Bad debts are not expected to be recovered, while doubtful debts may still be retrieved.
5. Companies write off bad debts with proper documentation and evidence that the debt is uncollectible, while doubtful debts require ongoing monitoring and assessment of the debtor’s financial situation.

Comparison Between Bad Debts and Doubtful Debts

Parameters	Bad Debts	Doubtful Debts
Definition	Debts that are considered uncollectible and are written off as losses by the company	Potentially uncollectible debts but their losses are uncertain
Recognition	Recognized as expenses immediately when it becomes clear they are uncollectible	It was initially recognized as an allowance or provision for potential losses, with a specific amount set aside.
Accounting treatment	Reduce accounts receivable and directly impact the income statement	Recorded as a contra-asset on the balance sheet
Recovery	Not Recovered	May recover in the future
Documentation	Proper and with evidence that the debt is collectable	Require ongoing monitoring and assessment of the debtor’s financial situation

References

1. http://dspace.mnau.edu.ua/jspui/handle/123456789/11335
2. https://www.sciencedirect.com/science/article/pii/0378426680900230