What Is Bad Debt In Singapore? A Deep Dive Into Credit Challenges
October 6, 2023
Any firm that extends credit to its clients faces the risk of bad debt expense, which can profoundly affect its bottom line. Business operations can streamline, and severe financial losses mitigated if the company provides for such contingencies through a bad debt provision, also known as an allowance for doubtful accounts. This is an expense that a business incurs once the repayment of credit previously extended to a customer is estimated to be uncollectible, in accordance with generally accepted accounting principles (GAAP).
But what exactly do we mean by bad debt? Keep reading to find out what is bad debt, examples, and how to deal with bad debt in Singapore.
Bad Debt: Definition
Bad debt in accounting is monetary obligations owing to a company or corporation deemed improbable to be repaid. It is an indication of a company’s unpaid balances regarded as being uncollectible. In credit institutions, it happens when customers fail to make timely payments on their accounts receivable. This is where the concept of bad debt expense must be estimated using the allowance method comes into play.
Suppose a corporation extends credit to a client for purchasing its products and said consumer fails to fulfil their payment obligations per the agreed-upon terms. In that case, the transaction falls under irrecoverable debts after reasonably attempting to collect the outstanding balances. This is where the principle of debt expense must be estimated comes into play. The balance in the account of accounts receivable becomes crucial in understanding bad debt expense.
Customers might not make payment of money owed to a company due to financial crisis impact, bankruptcy, or negligence in payments. This is a situation where the business incurs once the repayment of credit previously extended to a customer becomes a bad debt expense.
Bad Debt Example
SG Ltd., a retail establishment, sells merchandise valued at $10,000 to XYZ, a customer, through a credit transaction. XYZ has filed for bankruptcy under insolvency issues. Thus, they will unlikely pay the debt. XYZ’s outstanding $10,000 owed to SG Ltd. will now be a defaulted debt, representing a bad debt expense to SG Ltd.
Accounting for Bad Debt Expense
The defaulted debt contingency account, also known as allowance for doubtful accounts, is a contra-asset item. Methods to record bad debts in Singapore include the direct write-off method and the allowance method, both of which are methods for estimating bad debt expense. These methods are in line with generally accepted accounting principles (GAAP).
Methods To Record Bad Debts In Singapore
To document money unlikely to be refundable in the financial records, companies must initially assess the potential losses they may incur. This particular estimation is a bad debt provision, reserve, or allowance. The allocation for uncertain payments is the contra-asset entry on the financial statement, acting as a contra account to accounts receivable. This is where the principle of debt expense can be estimated using the allowance method comes into play.
Write-Off Of Bad Debts
Many Singaporean small enterprises employing International Financial Reporting Standards (IFRS) may opt for a bad debt write-off method. Debt is immediately documented in the records once it’s determined that a receivable is hopeless. The amount is deductible from the total accounts receivable, impacting the balance sheet. This is known as the direct write-off method, one of the two main ways to handle bad debts.
When the bad debt amounts exceed the bad debt provision, the difference comes up as an expenditure in the relevant financial year’s income statement. As a result, the company’s net profits for that specific accounting year reduce. This is where the concept of “debt expense must be estimated using the allowance method” is particularly relevant.
GST Bad Debts Relief
In Singapore, companies can recover debt by reclaiming GST paid to non-performing accounts. The Inland Revenue Authority of Singapore (IRAS) provides a relief scheme for over six months old invoices, subject to specific circumstances. This is an example of how bad debt can also be managed through governmental programs.
Accounting Entry For Bad Debt
To recognise this bad debt expense, the company must execute an accounting transaction to represent the incurred loss accurately. Accounting entry for bad debt entails a debit to the bad debt expense account and a credit to the contra-asset account, which is the allowance for doubtful accounts. This is in line with the principle used in accrual accounting and generally accepted accounting principles (GAAP).
A bad debt status is only assigned to the account when a corporation believes it cannot collect the outstanding amounts owed and remove it from its financial records. The transaction involves debiting the ‘allowance for dubious accounts’ and crediting the ‘accounts receivable.’ This is where the concept of “debt expense must be estimated” is particularly relevant.
Suppose settlement is ultimately received for previously written-off bad debts. The said amounts will be duly documented in the recovery account, known as bad debt recovery. In an alternative approach, companies in Singapore can revert the initial transaction when writing off a noncollectable debt, afterwards recording the receipt of payment.
Estimation Of Bad Debt Expense: Methods for Estimating and Understanding Bad Debt
Following the ‘matching’ accounting principle, enterprises must estimate their bad debt expense charges throughout the fiscal year during credit sales. The matching principle used in accrual accounting and generally accepted accounting principles (GAAP) ensures that revenues and expenses are recorded in the same accounting period.
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The measure of bad debt expense allocation is possible using the following two different approaches as per Singapore’s financial practices:
Percentage Sales: A Method for Estimating Bad Debt Expense
In the percentage sales method, the debt expense can be estimated using historical data as a foundation, and a constant proportion applicable to total sales. This historical experience with bad debt helps in determining the bad debt expense for the period.
As an illustration, historical patterns indicate that 3% of a company’s sales are often uncollectible, given sales amounting to $100,000. The estimated bad debt expense for the year would be $3,000.
Likewise, if sales reach $150,000, a company incurs a bad debt expense of $4,500 in the year in question. The provision for doubtful accounts will reflect a combined balance of $7,500 for the two reporting times.
Accounts Receivable Ageing Method: Estimating Uncollectible Accounts
Here the company will add up all of its aged accounts receivable to determine the total amount likely to become uncollectible. Next, it will calculate percentages of delinquent and bad debt for each age range based on norms and statistics from the sector.
As accounts receivables mature, default risk increases and collections decline. Dun and Bradstreet say the collection rate is 69.6% for accounts receivable older than 90 days. After six months, this percentage reduces until 52.1%; after a year, it is 22.8%.
Consider the hypothetical case of SG Ltd., which has $50,000 and $30,000 in accounts receivable. These are overdue by less than 30 and 60 days.
According to past performance, the company should expect to write off 1% of outstanding accounts after 30 days and 5% after 60 days. So, here is how we’ll calculate the defaulted bad debt expense:
Defaulted bad debt expense = ($50,000 x 1%) + ($30,000 x 5%)
Defaulted bad debt expense = $500 + $150 = $650
This figure, however, reduces after estimating the debts for the following reporting period. For the next accounting period, only $340 ($650 minus $990) will fall under bad debt expense because the bad debt allowance was $990.
How Do You Deal With Defaulted Debt In Singapore: Strategies and Allowances
Even with precautions taken, thorough background checks performed, and credit limitations set, several invoices might still go unpaid, leading to an increase in your accounts receivable. Here are some critical approaches to dealing with defaulted debt:
Immediate Follow-up: Managing Accounts Receivable
Collections can be faster by prompt follow-ups on overdue invoices with automated frequent reminders in regular phone calls or defaulting debt letters. This is a crucial step in managing your accounts receivable and reducing your bad debt expense.
Debt Negotiation Strategies: Allowance and Bad Debt Expense
You can speed up payments by providing payment schedules to consumers with financial troubles. This is where understanding bad debt and having an allowance for doubtful accounts can be beneficial.
Engage The Services Of Debt Collectors: Contra Account Measures
If you haven’t received payment after several warnings, contacting debt collection agencies in Singapore may be your best option. These organisations have the workforce and knowledge to pursue compensation from customers that have fallen behind, thereby reducing your bad debt expense.
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Key Takeaways: Bad Debt Expense Must Be Estimated
A corporation’s defaulted debt is the amount of money its customers owe the company but are highly unlikely to repay. This is why a bad debt expense must be estimated and why an allowance for doubtful accounts is essential for any business that extends credit.