I was reading an article about financial statements, and I came across the term "Bad Debt" which falls under the category of unusual expenses on an income statement. Some companies just write off a bad debt as an expense on the income statement. But my question is how does it affect the balance sheet? A debt such as an accounts receivable is shown as an asset on the balance sheet. So if we remove an asset from the sheet, won't this mean that the balance sheet no longer balances out?
The accounting equation is like so: : Assets - Liabilities = Equity (Owners or Shareholders)
When an entity first makes a transaction (like, say, a sale with payment arrangements to collect money later), the entity sees an increase in Assets (the debt owed them, accounts receivable). To keep things balanced, they also recognize the increase to Equity.
When the entity realizes (on paper) that the debt was bad and they aren't going to be paid, they decrease equity as well in equal measure.
Remember: the balance sheet stays "balanced" - so any set of changes must equally effect all aspects of the accounting equation - but that doesn't mean it doesn't change. By "writing off" a bad debt, the entity has recognized it lost money and they aren't going to ever collect on that debt after all. In double-entry accounting every debit there is a credit, and thus also "balance".
The debt is "off the books" because you don't continue to consider it in accounts going forward from the period the loss was recognized.
you don't just remove it from the balance sheet, but 'write if off' as a loss. It will then be in the gain/loss total (reducing the gain accordingly), and the balance sheet will still balance out.
Conceptually, it is treated like buying a chocolate bar and eating it - you have a payment, but no asset for it anymore, so it is a loss
You have to reduce the amount of debtors by the amount of bad debts. Hence, the amount of bad debts is deducted from the Debtors in the Current assets in Balance Sheet to show the true and fair position of assets..