Bad Debts Recovered- Partnership Adjustments Part 8

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Introduction

In this article we will learn about the adjustment for adjustment for Bad Debts recovered in partnership accounts.

Please note that the adjustment will be done in a similar manner whether you are doing admission, retirement, death or change in profit ratio question. You need not understand the adjustments separately for these chapters.

Meaning of Bad Debts

Lets understand the meaning of bad debts with the help of a case study

A partnership firm is formed to do business and earn profits . The firm earns profits when it makes sales of either goods or services. The sales can be made either in cash or on credit.

Cash Sales means that the purchaser will make the payment immediately. Credit sales means that the purchaser will make the payment after some days like for example after 2 months. When a firm makes credit sales then this is recorded as a debtor in the books of accounts. Firm makes credit sales to many people. The sum of amount of all the debtors is called Sundry Debtors.

Some of the people who are debtors for the firm, may not make the payment even after the agreed time. The firm will incur a loss due to this. In other words, the debtors have become bad and hence called bad debts. Bad Debt is a loss for the firm. This is charged to the profit and loss account. It is shown on the debit side of profit and loss account.

graph LR A[Sales] --> B[Cash Sales] A --> C[Credit Sales] B --> D[Payment made immediately] C --> E[Payment made after agreed time] E --> F[Money not paid after agreed time] F --> G[Known as Bad Debt] style A fill:#f9f,stroke:#333 style B fill:#ccf,stroke:#333 style C fill:#f96,stroke:#333 classDef default stroke:#333,fill:#fff;

Meaning of Bad Debts Recovered

We have understood the meaning of bad debts and its treatment in accounts. Now we understand what are bad debts recovered.

Bad debts are recovered when later on, some of the people whose debts became bad earlier, may chose to make the payment to the firm. Since the firm now receives the payment which became bad earlier so this is called bad debts recovered. The debt was earlier considered bad and charged as expense, but now it is recovered so this is a profit for the firm.The money recovered can be full or partial.

Suppose a debtor was for Rs 5000. It became bad in the past. Now that debtor has paid full Rs 5000. It is called full recovery. If the debtor only pay suppose Rs 3000 then it is called partial recovery.

graph LR A[Bad Debts] --> B[Charged to Profit and Loss Account] B --> C[Later] C --> D[Payment made] D --> E[Fully] D --> F[Partially] E --> G[Bad Debts recovered fully] F --> H[Bad Debts recovered partially] classDef default stroke:#333,fill:#fff;

Meaning of Insolvent person

In this context let's also understand the meaning of insolvent person. An insolvent person is one who has lost all his or her money. Now he is not left with enough money to repay all his liabilities. In other words an insolvent person is a person, whose Liabilities are more than his assets. He is in a position where he is not having enough assets to repay all his liabilities.

graph LR A[Insolvent] --> B[Who has lost his money] A --> C[His Liabilities < Assets] A --> D[Cannot pay off his liabilities fully with available assets] classDef default stroke:#333,fill:#fff;

Meaning of Estate

In bad debts question you will also find another term "Estate". The question could say that 50% amount recovered from his estate.

What is an estate? Estate means the total assets left with the person who has become insolvent.

Estate can include any asset like tangible assets land and building, gold, vehicles, furniture, Jewellery or intangible assets like trademarks, copyright, software or other assets like cash, bank or investments.

Actually the bad debts recovery by the partnership firm, is from the amount received by the insolvent person, by selling his estate or assets left with him.

How Bad Debts recovered adjustment given in the question

A debtor whose dues of Rs 3000 were written off as bad debts paid 50% in settlement
A debtor whose dues of Rs 3000 were written off as bad debts paid Rs 1500 in full settlement
Mohan an old customer whose account was written off as bad, has promised to pay Rs 1500 in full settlement
In the past, Rs 5000 debts became bad. 60% of the debt is now paid back by the debtor.

Please note that what whatever the language in question is, the adjustment will be done in similar manner. Let's understand how to do this adjustment.

Understand Bad Debts recovered adjustment

Since money is received so cash or bank which is an asset increase. So bank account gets debited.

Since the firm recovers lost money so there is a profit. Due to profit there will be revaluation gain

Important Note

If the question says that, debtor has 'promised to pay', instead of 'paid' then, no cash is received by the firm. In this case debtors account gets debited instead of cash or bank account.

Calculation of Amount of Journal Entry for bad debts recovered

Now we will understand the amount for which the entry will be passed. Suppose the bad debt was Rs 5000.
- If the question says that full amount is recovered then entry will be passed by Rs 5000.
- If the question says that 40 percent amount is recovered then entry will be passed by Rs 2000
- If the question says that 50 percent amount is recovered then entry will be passed by Rs 2500
- If the question says that 60 percent amount is recovered then entry will be passed by Rs 3000

Similarly you can find the amount for any other percentage given in the question.

Bad debts recovered Journal Entry

If the language of the question says that the bad debts recovered is paid

Cash/Bank A/c Dr.. Rs 5000
- To Revaluation A/c Rs 5000

If the language of the question says that the bad debts recovered are promised to be paid

Debtors A/c Dr.. Rs 5000
- To Revaluation A/c Rs 5000

The firm is receiving money so either cash or bank account gets debited. As discussed earlier, the firm is making a revaluation gain so revaluation account gets credited. Debit debtors account instead of cash or bank, if the debtor has just promised to pay but have not actually paid the money till now.

graph LR A[Journal Entry] -->B[Bad Debts Recovered]--> C[Debit] C -->D[Paid]--> E[Cash/Bank] C -->F[Promised to Pay]--> G[Debtors] B -->H[credit]--> I[Revaluation A/c] classDef default stroke:#333,fill:#fff;

Bad Debts recovered in Revaluation Account

Particulars	Amount	Particulars	Amount
		By Cash/Bank/Debtors A/c	5000

Since there is a profit, so it will be shown on credit side of revaluation account.

If money is paid then write cash or bank. If the money is promised to pay then write debtors.

There will be no entry on the debit side of revaluation account

Bad debts recovered in Partner Capital A/c

Particulars	A	B	Particulars	A	B

There will be no impact in partner capital account as we have not passed any entry in partner capital account

Bad Debts recovered in Balance Sheet

Liabilities	Amount	Assets	Amount
		Cash/Bank/Debtors	+5000

Next we will discuss how this adjustment will be shown in the balance sheet. In the balance sheet the value of assets will be increased. In our example on the assets side the amount of cash or bank will be increased if the question says that the money is paid. If the question says that the person has 'promised to pay' and have not actually paid yet then debtors will be increased instead of cash or bank account.

Finally

Here is the summary of the whole bad debts recovered adjustment.

graph LR A[Bad Debts Recovered] -->B[Revaluation Account]--> C[Credit Side] A[Bad Debts Recovered] -->D[Partner Capital Account]--> E[No Impact] A[Bad Debts Recovered] -->F[Balance Sheet]--> G[Write on Assets Side] classDef default stroke:#333,fill:#fff;

That's all for this adjustment. Please go through below links for more partnership accounts adjustments on reconstitution.

Partnership Accounts Index