A bad debt is an account receivable that has been clearly identified as not being collectible.

This means that you remove that specific account receivable from the accounts receivable account, usually by creating a credit memo in the billing software and then matching the credit memo against the original invoice, which removes both the credit memo and the invoice from the accounts receivable report. When you create the credit memo, you credit the accounts receivable account and debit either the bad debt expense account (if there is no reserve set up for bad debts) or the allowance for doubtful accounts (which is a reserve account that is set up in anticipation of bad debts). The first alternative for creating a credit memo is called the direct write off method, while the second alternative is called the allowance method for doubtful accounts. A doubtful debt is an account receivable that might become a bad debt at some point in the future. You may not even be able to specifically identify which open invoice to a customer might be so classified. In this case, you create a reserve account for accounts receivable that may eventually become bad debts, estimate the amount of accounts receivable that may become bad debts in any given period, and create a credit to enter the amount of your estimate in this reserve account, which is known as the allowance for doubtful accounts. The debit in the transaction is to the bad debt expense. When you eventually identify an actual bad debt, you write it off (as described above for a bad debt) by debiting the allowance for doubtful accounts and crediting the accounts receivable account. For example, ABC International has $100,000 of accounts receivable, of which it estimates that $5,000 will eventually become bad debts. It therefore charges $5,000 to the bad debt expense (which appears in the income statement) and a credit to the allowance for doubtful accounts (which appears just below the accounts receivable line in the balance sheet). A month later, ABC knows that a $1,500 invoice is indeed a bad debt. It creates a credit memo for $1,500, which reduces the accounts receivable account by $1,500 and the allowance for doubtful accounts by $1,500. Thus, when ABC recognizes the actual bad debt, there is no impact on the income statement - only a reduction of the accounts receivable and allowance for doubtful accounts line items in the balance sheet (which offset each other).

A bad debtis an amount that is written off by the business as a loss to the business and classified as an expense because the debt owed to the business is unable to be collected, and all reasonable efforts have been exhausted to collect the amount owed. This usually occurs when the debtor has declared bankruptcy or the cost of pursuing further action in an attempt to collect the debt exceeds the debt itself. [1] [2] [3] The debt is immediately written off by crediting the debtor's account and therefore eliminating any balance remaining in that account. A bad debt represents money lost by a business which is why it is regarded as an expense.
Doubtful debts are those debts which a business or individual is unlikely to be able to collect. The reasons for potential non payment can include disputes over supply, delivery, and conditions of goods, the appearance of financial stresswithin customers operation. When such a dispute occurs it is prudent s add this debt or portion thereof to the doubtful debt reserve. This is done to

avoid over-stating the assets of the business as trade debtorsis reported net of Doubtful debt. When there is no longer any doubt that a debtis uncollectable the debt becomes bad. An example of a debt becoming uncollectable would be:- once final payments have been made from the liquidation of a customer's limited liability company, no further action can be taken.

Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, in accordance with the directions or guidelines relating to asset classification issued by The Reserve Bank of India.

[edit] Ninety days overdue

Nonperforming Asset

What Does Nonperforming Asset Mean? A debt obligation where the borrower has not paid any previously agreed upon interest and principal repayments to the designated lender for an extended period of time. The nonperforming asset is therefore not yielding any income to the lender in the form of principal and interest payments.

Investopedia explains Nonperforming Asset For example, a mortgage in default would be considered non-performing. After a prolonged period of non-payment, the lender will force the borrower to liquidate any assets that were pledged as part of the debt agreement. If no assets were pledged, the lenders might write-off the asset as a bad debt and then sell it at a discount to a collections agency.

latter case, i.e, credit basis, there may be a chance of non payment or non recovery. That part of receivables which is left unrecovered is known as bad debt. In simple words the debt which has turned bad, i.e, irrecoverable. Accounting Process: The accounting process in both cases differs. In case of cash transactions the incomes are recorded as and when the transaction takes place. In case of credit terms, however, the transactions are recorded in the name of debtors and income is recorded only when they are received. As it happens in almost all businesses, there is a chance of non payment and hence a provision needs to be made for the same. Accounting for Bad Debts: There are two ways of recording bad debts.

 Direct write-off: This involves a directly writing off the debts from the receivables account and hence in this case the accounts do not match. The principles of conservatism and matching concept are violated and hence this method is generally not adopted. Allowance method: since this method is according to GAAP, it is most widely used and accepted. Here, the revenues are match to the expenses and the principle of conservatism is also taken into consideration. Direct Write Off:
In this method the debts are considered bad only when the customer fails to pay and it is certain that there will be no recovery. Its favorable point is that it is based on facts and not on estimation. The accounting involves debiting the bad debts account and crediting debtors/receivables account. Though the method is based on actual occurrence of bad debts, it is not accepted for reporting and accounting because it fails the principle of matching revenues with expenses. Allwance Method: In every business there are certain customers who default in paying their dues and hence lead to losses of revenue. In order to cushion the business from such instances, a provision is made in the income statement. It is important to note here that the accounting for bad debtsis done at theend of the year and is made as an adjustmententry in the income statement. The amount of provision made maybe calculated on the basis of: past records of debtors/receivables or Made as a fixed percentage of the debtors. Provision created for bad debts should be of reasonable amount since it is made out of the profits. Enteries in the Books of Accounts: When the provision is made, the income statement/ profit and loss account is debited and the provision appears in the balance sheet on liabilities side under the head of current liabilities and provisions. Or it is deducted from the debtors on the asset side. When all efforts of recovering the debts have failed and reasonable time period has passed, the debt is then considered irrecoverable. When a bad debt actually occurs, that is known as bad debt expense, an adjustmententry is made. In income statement, the provision is reduced to the extent of bad debt expenses and correspondingentries are made in the balance sheet. It is important to note here that the effects in P/L account and balance sheet will only be correctly made if the journalentries are correct. In case of actual default the provision account is debited and debtors account is credited. The effect of adjustmententry is shown in both the statements- P/L account and balance sheet, as explained earlier. Recovery of Bad Debts: In very rare cases, the defaulting debtor clears his unpaid (considered as irrecoverable earlier) debts. In such cases entries have to be made to account for the income. Here, the receivables/debtors account is debited and the provision account is credited. It is a reverse entry of the previously made entry. Another entry is made- cash account debited and debtors account is credited- to account for the cash received. Importance of Provision:

After discussing the accounting practices for bad debts, it is important to discuss the reason for making provisions and maintaining the accounts correctly. GAAP, i.e., Generally Accepted Accounting Principles, clearly states the need for conservatism and following the concept of matching revenues with expenses. The principle of conservatism is the basis for creating the provision for bad and doubtful debts. Since the debts do not become expense immediately, they are also called doubtful debts. The provision helps business organizations in creating a cushion for itself against bad debt expenses and future losses there from. Since creating provisions involves additional entries in the journal, it is important to understand the process and implement it correctly. Any mistake may lead to differences in the balance sheet which would require further time and efforts to be corrected. The key is to follow the process step by step and balancing the statements accordingly. The calculation of provision amount also requires due care. The methods of the same have been discussed earlier and importance is again emphasized here. The provision created should be of such an amount that neither is too large nor too small. Since the amount is appropriated from the revenues of the business, it is imperative that the provision does not exceed to an extent which maybe considered as a drain on the resources. At the same time, it should not be so small such that the bad debt expenses actually incurred exceed the provision. In such situations there are losses to the business despite of the provision. Hence, amount of provision is as important as creating the provision itself. Conclusion: The accounting practices discussed above are relevant for almost all kinds of businesses, yet the actual practices may differ depending upon the conventions followed and the unique nature of the business. Though all the relevant matter regarding accounting for bad debtshas been discussed, the following are the related topics which might interest the reader: Taxability of bad debts Credit control and minimization of bad debts credit rating collection of bad debts Accounting Conventions: The term 'conventions' includes those customs or traditions which guide the accountant while communicating the accounting information. 1. Conservatism:
According to this convention accounts follow the rule "anticipate no profit but provide for all possible losses", while recording business transactions. In other words, the Accountant follows the policy of "playing safe". On account of this convention, the inventory is valued at cost or market price whichever is less! Similarly a provision is made for possible bad and doubtful debts out of current year's profits. This concept affects principally the category of current assets. The convention of conservation has been criticized these days as it goes against the convention of full disclosure. It encourages the accountant to create secret reserves (e.g. by creating excess provision for bad and doubtful debts, depreciation etc.), and the financial statements do not show a true and fair view of state of affairs of the business.

2. Full Disclosure:

According to this convention the users of financial statements (proprietors, creditors and investors) are informed of any facts necessary for the proper interpretation of the statements. Full disclosure may be made either in the body of financial statements, or in notes accompanying the statements. Significant financial events occurring after the balance sheet date, but before the financial statements have been issued to outsiders require full disclosure. The practice of appending notes to the financial statements (such as about contingent liabilities or market value, of investments or law suits against the company is in pursuant to the convention of full disclosure.

3. Consistency:
This convention states that once an entity has decided on one method, it should use the same method for all subsequent events of the same character unless it has a sound reason to change methods. If an entity made frequent changes in the manner of handling a given class of events in the accounting records, comparison of its financial statements for one period with those of another period would be difficult. Consistency, as used here, has a narrow meaning. It refers only to consistency over time, not to logical consistency at a given moment of time. For example fixed assets are recorded at cost, but inventories are recorded at the lower of their cost or market value. Some people argue that this in inconsistent. Whatever the logical merits of this argument, it does not involve the accounting concept of consistency. This convention does not mean that the treatment of different categories of transactions must be consistent with one another but only that transactions in a given category must be treated consistently from one accounting period to the next.

4. Materiality:
The term materiality refers to the relative importance of an item or an event. An item is "material" if knowledge of the item might reasonably influence the decisions of users of financial statements. Accountants must be sure that all material items are properly reported in the financial statement. However, the financial reporting process should be cost-effective - that is, the value of the information should exceed the cost of its preparation. In short, the convention of materiality allows accountants to ignore other accounting principles with respect to items that are not material. An example of the materiality convention is found in the manner in which most companies account for low-cost plant assets, such as pencil sharpness or wastebaskets. Although the matching concept calls for depreciating plant assets over their useful life, these lowcost items usually are charged immediately to an expense account the resulting "distortion" in the financial statement is too small to be of any importance.

Accounting is the language of business and it is used to communicate financial information. In order for that information to make sense, accounting is based on 12 fundamental concepts. These fundamental concepts then form the basis for all of the Generally Accepted Accounting Principles (GAAP). By using these concepts as the foundation, readers of financial statements and other accounting information do not need to make assumptions about what the numbers mean. For instance, the difference between reading that a truck has a value of $9000 on the balance sheet and understanding what that $9000 represents is huge. Can you turn around and sell the truck for $9000? If you had to buy the truck today, would you pay $9000? Or, perhaps the original purchase price of the truck was $9000. All of these assumptions lead to very different evaluations of the worth of that asset and how it contributes to the companys financial situation. For this reason it is imperative to know and understand the eleven key concepts.

ELEVEN KEY ACCOUNTING CONCEPTS

Entity Accounts are kept for entities and not the people who own or run the company. Even in proprietorships and partnerships, the accounts for the business must be kept separate from those of the owner(s). Money-Measurement For an accounting record to be made it must be able to be expressed in monetary terms. For this reason, financial statements show only a limited picture of the business. Consider a situation where there is a labor strike pending or the business owners health is failing; these situations have a huge impact on the operations and financial security of the company but this information is not reflected in the financial statements. Going Concern Accounting assumes that an entity will continue to operate indefinitely. This concept implies that financial statements do not represent a companys worth if its assets were to be liquidated, but rather that the assets will be used in future operations. This concept also allows businesses to spread (amortize) the cost of an asset over its expected useful life. Cost An asset (something that is owned by the company) is entered into the accounting records at the price paid to acquire it. Because the worth of an asset changes over time it would be impossible to accurately record the market value for the assets of a company. The cost concept does recognize that assets generally depreciate in value and so accounting practice removes the depreciation amount from the original cost, shows the value as a net amount, and records the difference as a cost of operations (depreciation expense.) Look at the following example: Truck $10,000 purchase price of the truck Less depreciation $ 1,000 amount deducted as a depreciation expense Net Truck: $ 9,000 net book-value of the truck