Hi shivani,
If debtor is simply saying he won’t pay the balance, in my opinion, we can’t book the difference as bad debt as long as we have a legal right to enforce our claim through the court of law and more importantly, we plan to sue the debtor. Our decision, relating to whether to go to the court, may depend on many things like the quantum of amount involved etc. in the above case, If we don’t plan to initiate legal proceedings, then certainly, the difference is bad debt and can be booked accordingly.
A person cant declare himself as an insolvent, but he has to file insolvency petition in the court and normally, the list of persons to whom he owes money and their respective amounts will be circulated among his creditors and after getting their representations through their advocates, the court may declare such a person as insolvent and discharge from his liabilities and the amount due to the creditors will be proportionately settled from the sale proceedings from his estates, if any, under the supervision of the court.
I’m not sure, whether there are any additional procedures, but these are the basic procedures relating to insolvency. The pivotal point here is that there is a long time gap (may be 3-4 years or even more when the number of creditors is large) between the person filing IP petition and declaring him as insolvent.
Moreover, some amount may be recovered from him ultimately from his estate, even if we don’t know the exact recoverable amount at the time of his filing petition. That’s why, I’m saying we can’t write off fully the outstanding balance at that time, in the absence of adequate information. Therefore, we have to make a provision for the full outstanding balance at time of filing his petition and when he becomes a declared insolvent, we should reverse the full provision and debit bad debts for the amount that has become irrecoverable.
1. Bank a/c Dr (Recovered Amount)
Baddebts Dr (Irrecoverable amount)
To debtor
2. Provision for bad debts
To P&L
But as per Income Tax Act, we can claim bad debts, if we have simply written off it in our books of accounts. There doesn’t require any conclusive evidence that the amount has actually become irrecoverable. In many cases, courts have taken the view that evidence is not necessary for writing off the outstanding balance as bad debts; rather the assesee merely require to actually writing off the amount as bad debts in his books of accounts. That’s the reason why, in practical cases, we immediately write off the debtor balances as bad debts, as and when it become merely doubtful; as it is an admissible deduction for income tax purpose. But this is a sort of concession given in Income Tax Law and is not strictly in accordance with the accounting theory. We have to understand, all what we do for tax purpose may not be correct from accounting point of view.
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