As a business, we always have a bad business/individual that gets defaulted & we as a business have to bear the cost of the service/ cost of the good.
Bad debts are very unfortunate. However, ATO is generous & helps us claim a deduction for bad debts.
To claim the deduction:
This policy covers:
- Raising of invoices and credit notes;
- Management of long outstanding debts;
- Authorisation of invoices and credit notes.
The existing debt must be bad, it is sufficient for the debt to be determined as uneconomic to recover.
This policy and any associated producers should be used in all cases where payment for the provision of goods services, lease, licenses etc is deferred by the provision of credit to the customer.
The existing debt must have been previously brought to account as assessable income or represent monies lent in a money-lending business. (Note that this requires the taxpayer to be returning income on an accruals basis.)
The existing debt must have been written off as a bad debt during the income year. Therefore, taxpayers should ensure that accounts receivable are reviewed before the end of the financial year to ensure any bad debts are written off.
An allowance for doubtful debt does not meet the requirements which have not yet been written off and will not be deductible as a bad debt.
The entity acquired goods or other property or services and the financial benefits the entity is to provide under the arrangement are a consideration for those goods or other property or services.
The arrangement is not a derivative financial arrangement for any income year.
Let’s assume that ABC Corp., a manufacturer of industrial soaps, reports an ending balance of $250,000 in accounts receivable on its balance sheet, or statement of financial position. The company also reports customer sales of $950,000 on its income statement or statement of earnings.
Assume ABC Corp. uses the sales approach for calculating bad debt, and management estimates based on past history that 3 percent of sales will be uncollectible. The bad debt estimate would be $28,500 (.003 x $950,000). The journal entry to record the expense to the company’s general ledger would be Bad Debt Expense $28,500 Allowance for Losses $28,500. When using the sales approach, any prior balance in the allowance account is not considered when booking the entry. This differs from the accounts receivable approach.
Accounts Receivable Approach
Assume instead that ABC Corp. uses the accounts receivable approach for calculating bad debt. According to management, 2.5 percent of accounts receivable has been uncollected over previous years. The bad debt estimate would be $6,250 (.025 x $250,000). The journal entry to record the expense to the company’s general ledger would be Bad Debt Expense $6,250 Allowance for Losses $6,250. Unlike the sales approach, the balance in the allowance account is always adjusted to reflect its current percentage of the accounts receivable balance. If the balance in the allowance account had been $2,000 before the entry, only $4,250 would have been needed for the adjusting entry.