Home Accounting Understanding Accounting and Tax Treatment of Bad Debts

Understanding Accounting and Tax Treatment of Bad Debts


It is inevitable for corporate bodies and individuals to transact on credit terms with their respective clients or customers; this gives rise to trade debtors or accounts receivables for a given financial period.

However, it should be clearly understood that these debtors or receivables may not be realized or recovered. It is necessary, therefore, to make a provision or an allowance for doubtful debts or even to write off some of these debts.

The accounting and tax treatment for provision or allowance for doubtful debts differ from that of irrecoverable debts. The treatment of provisions for both accounting and tax purposes shall be discussed in the next article.

Today, we shall remain faithful to our chosen subject of understanding the accounting and tax treatment of irrecoverable debts or bad debts written off.

Irrecoverable debts occur whenever a client or a credit customer fails to clear a debt either fully or partially. This simply means that the amounts cannot be realized hence a need to write them off. The bad debts could arise due to; Insolvency of the credit customers to the extent that nothing can be recovered at all from them, the Death or mental problems of the credit customers, and nothing can be recovered from their estates, Liquidation of the Credit customers’ business operations among others.

Once the company realizes that debts are unlikely to be recovered, then the immediate action must be to write them off. This is in compliance with the prudence concept that is clearly defined in the conceptual framework for financial reporting.

The writing off of irrecoverable debts ensures that the debtors or receivables are not overstated with what cannot be prudently recovered or realized; Failure to write off such debts could mislead the shareholders and other users of financial information in making economic decisions.

Irrecoverable debts or bad debts are recognized as operating expenses through the statement of profit and other comprehensive income in the period to which they relate and consequently reduced from the receivables or trade debtor’s figures in the statement of financial position.

Bad debts recovery

It is common that bad debts previously written off could be recovered or realized fully or partially at a subsequent date. In such a case, the effects of the previously written off bad debts must immediately be reversed if the recovery of bad debts occurs in the same period they were written off. This can be done by re-instating the receivables/debtors’ balance and recognizing the bad debts recovered income as follows; Dr. Trade debtors or receivables A/c, Cr Bad debts recovered A/c. In recognition of the amounts received, the below entries should be made: Dr. Cash book A/c, Cr Trade debtors or receivables A/c.

In this case, the amounts in the bad debts recovered account should then be presented as income in the statement profit or loss and other comprehensive income for the period in which the recoveries were made.

It should be noted that where bad debts previously written off are recovered in subsequent periods other than the period in which they were written off, the effect of the previously written off bad debts shall not be reversed i.e. the previous bad debts expenses shall not be canceled or reversed and as well the receivable balances shall not be re-instated. However, the reporting entity shall simply recognize the amount received from such recoveries by passing the following accounting entries; Dr. Cash book, Cr Bad debts recovered A/c.

For taxation purposes

Under the Income Tax Act, Cap 340-(sec 24), Irrecoverable debts or bad debts written off are allowable deductions for tax purposes only if the amount of the bad debts was; included in the person’s gross income in a given year of income, In respect of amount lent in the ordinary course of a business carried on by a financial institution.

For the case of persons other than financial institutions, bad debt is allowed as a deduction only if all reasonable steps for it to be recovered have been taken and that the debt will not be recovered. Reasonable steps taken could include adherence to the company credit policy, engaging lawyers or debt collectors, sending reminders among others.

For the case of a financial institution, bad debts provided for in accordance with the Bank of Uganda Regulations are allowable deductions for tax purposes.

Recovered Bad debts treatment

Bad debts recovered are treated as income and therefore taxed for the period in which the recoveries are made provided that they were allowed as a deduction for the period in which they were previously written off.

Previous articleBoth Bijambiya and Bomb Terrorists Deserve the Same Fate
Next articleAirtel Masaza Cup; Defending Champions Gomba Drawn alongside two time Champions Ssingo, Kyadondo, Kabula and Buluuli


Please enter your comment!
Please enter your name here