Accounting for bad debts and early payment discounts

Whenever a company sells its products and services the amount is either paid in cash on hand or the customers are allowed to pay for the products later. Whenever the customer pays for the product later it is called purchasing a product on credit and is consider being an asset for the company that is recorded in accounts receivable in the form of short term assets. There are several situations that may arise on credit payments. Here we are discussing two of them as under:-

Accounting for Bad Debt

Whenever a customer purchases on credit and is unable to pay later the amount that is to be paid by the customer is considered as a bad debt for the company. In order to deal with bad debt intelligently the companies estimate the amount of bad debt that is going to be accumulated in that accounting period. The bad debt is reported as an expense at the end of that accounting period. This means that the bad debt account is debited as a result it appears as an expense in the income statement of that accounting period. In contrast to this the allowance of bad debt account is credited with the total amount of bad debt. At the end when an invoice unpaid is finally categorized as a bad debt the accounts receivable account is eliminated with credit and the allowance of bad debt that is a reserve account is debited.

Accounting for discount on early payments

Sometimes a company offers a discount to its customers if they pay early on the purchased products and services. In such cases customers take advantage of this situation and pay an amount that less than the total amount of the invoice. The discounted price is termed as the residual balance and it must be eliminated from the account receivable by crediting it into sales discount account of the balance sheet. The amount that is discounted will appear as a profit reduction in the income statement.