Vouchers, Bad Debts, and Depreciation

In the previous chapter, "Goods, Debtors, and Creditors", we learned the vocabulary of buying, selling, and owing money. We established that when you sell goods on credit, the buyer becomes your "debtor"—someone who owes you money.

But accounting is not just about knowing who owes you money or what you own. It is a strict, evidence-based discipline. If you claim a debtor owes you ₹50,000, the auditor will ask: Where is the proof? If that debtor's business collapses and they cannot pay you, how do you record that loss? And what happens to the value of the expensive delivery truck you bought last year as it slowly wears out from daily use?

To answer these questions, we need to understand four critical concepts that bridge the gap between a physical business event and the accounting record: Transactions, Vouchers, Insolvency/Bad Debts, and Depreciation.

The Foundation: What is a Transaction?

Before we can record anything in our books, an event must qualify as a business transaction. In our daily lives, a "transaction" might mean a conversation or a deal. In accounting, the word has a very strict, narrow definition.

If an event cannot be measured in money, it is not a transaction, and it will never enter the accounting books.

Imagine you own a furniture factory.

• You purchase ₹1,00,000 worth of timber. (This is a transaction. Money is exchanged for goods).
• You pay ₹15,000 for electricity. (This is a transaction. Money is exchanged for a service).
• You hire a brilliant new sales manager who will undoubtedly double your profits. (This is a highly valuable business event, but it is not a transaction. You cannot put a reliable, objective monetary value on a human being's future performance at the moment of hiring).

Every transaction has two sides: a giving aspect and a receiving aspect. When you buy timber for cash, you receive goods and you give cash. Accounting is simply the art of recording these dual aspects. But to record them, we need proof that they actually happened.

Vouchers: The Proof of the Pudding

Accounting relies on a concept called the "Objective Evidence Principle." This means that every single entry in your books of accounts must be supported by objective, verifiable documentary evidence. You cannot simply tell your accountant, "I spent ₹5,000 on office supplies today, please write it down." The accountant needs a piece of paper that proves it.

This piece of paper is called a voucher.

Source Documents vs. Accounting Vouchers

To truly understand how this works in a real business, we need to split the concept of a "voucher" into two steps: the raw proof (Source Document) and the internal instruction (Accounting Voucher).

1. Source Documents (The Raw Proof) These are the original, physical (or digital) documents generated at the exact moment a transaction takes place. They are the raw evidence. Common examples include:

• Cash Memo: Received when you buy goods for cash, or given when you sell goods for cash.
• Invoice (or Bill): Used for credit transactions. If you buy goods on credit, the supplier gives you an invoice.
• Receipt: A written acknowledgment that cash has been received. If a debtor finally pays you, you issue them a receipt.
• Pay-in-Slip: The form you fill out at the bank when depositing cash or cheques. The counterfoil (the small tear-off portion the teller stamps and gives back to you) is your source document.

2. Accounting Vouchers (The Internal Instruction) A source document like a supplier's bill just tells you what was bought and for how much. It does not tell the junior accountant how to record it in the books (which account to debit and which to credit).

Therefore, based on the source document, the business prepares an Accounting Voucher. This is an internal company form attached to the front of the source document. It translates the raw bill into accounting language. It says, "Debit the Office Supplies Account, Credit the Cash Account," and it is signed by an authorized manager before the accountant actually types it into the system.

Insolvency: When the Money Runs Out

Now that we know how to record transactions, let us look at what happens when a transaction goes wrong.

Suppose you sell goods worth ₹50,000 on credit to Mr. Sharma. Mr. Sharma is now your debtor. You have the invoice (voucher) to prove it. You expect him to pay in 30 days. But 30 days pass, then 60, then 90. You visit Mr. Sharma's shop and find it locked. You learn that his business has failed, he has massive debts, and he has no money left.

In legal and financial terms, Mr. Sharma has become insolvent.

To understand insolvency, we must contrast it with being solvent:

• Solvent: A person or business whose assets are greater than or equal to their liabilities. If they sold everything they owned, they could pay off everyone they owe.
• Insolvent: A person or business whose liabilities are greater than their assets. Even if they sold every single thing they owned, they still would not have enough cash to pay back their lenders and suppliers.

When a person becomes officially insolvent, a court often steps in. The court takes over whatever little assets the insolvent person has left, sells them, and distributes the cash proportionally among the people who are owed money.

Bad Debts: The Cost of Doing Business

Insolvency is what happens to Mr. Sharma. But how does Mr. Sharma's insolvency affect your accounting books?

You are owed ₹50,000. If Mr. Sharma is insolvent, you are not going to get that money. You cannot keep showing ₹50,000 as an asset (a debtor) in your books, because that would be lying about the true value of your business. You have to accept the loss and remove him from your list of debtors.

This unrecoverable money is called a Bad Debt.

Bad debts are an unfortunate but normal part of running any business that offers credit. They happen due to the insolvency of the debtor, the death of the debtor, or sometimes simply because a dishonest debtor absconds.

The "Paise in a Rupee" Concept

In Indian accounting problems, you will frequently encounter a very specific phrase when dealing with insolvency: "paise in a rupee".

Since there are 100 paise in one Rupee, this phrase is simply an old-fashioned way of stating a percentage.

• "60 paise in a rupee" means 60%.
• "25 paise in a rupee" means 25%.

When a debtor becomes insolvent, the court sells their remaining assets. Usually, there isn't enough to pay everyone in full. So, the court might announce that creditors will only receive "40 paise in a rupee" from the insolvent person's estate.

Let's look at how this works: Imagine a debtor, Ms. Gupta, owes you ₹10,000. She is declared insolvent. The official receiver of her estate informs you that a final dividend of "40 paise in a rupee" will be paid.

1. 1Total Debt: ₹10,000
2. 2Amount Recovered: 40% of ₹10,000 = ₹4,000. (This is recorded as Cash received).
3. 3Amount Irrecoverable: The remaining 60%, which is ₹6,000. (This is recorded as a Bad Debt).

You do not record the entire ₹10,000 as a bad debt—only the portion you permanently lost.

Depreciation: The Silent Expense

We have looked at how we lose money when people don't pay us. Now let's look at how we lose money simply by the passage of time.

Imagine you buy a brand-new delivery van for your business for ₹10,00,000. You have the voucher (the dealer's invoice). You record the van as an asset. Five years later, you decide to sell the van. Will anyone pay you ₹10,00,000 for it? Absolutely not. The van has been driven through rain and mud, the engine has wear and tear, and newer, better van models have been released. You might only get ₹3,00,000 for it.

The van lost ₹7,00,000 of its value over those five years. This gradual, permanent decrease in the value of a fixed asset is called Depreciation.

Why Does Depreciation Happen?

Assets lose value for three main reasons:

1. 1Wear and Tear: Physical deterioration from active use. A printing press running 12 hours a day will slowly wear out its gears and motors.
2. 2Efflux of Time: Some assets lose value simply because time passes, even if you don't use them. If you buy a 10-year lease on a warehouse, every year that passes means you have one less year of value left, regardless of whether you put anything inside the warehouse.
3. 3Obsolescence: Becoming outdated due to new technology or changes in market demand. A top-of-the-line computer bought three years ago might still work perfectly, but it has lost value because much faster computers are now available for the same price.

Why Do We Record Depreciation?

You might wonder: If I paid ₹10,00,000 for the van in 2020, why do I need to do extra math every year? Why not just record the expense when I bought it?

This brings us to the heart of accounting logic. The van is going to help you deliver goods and earn revenue for five years. If you record the entire ₹10,00,000 as an expense in Year 1, your Year 1 profits will look artificially terrible, and your profits in Years 2, 3, 4, and 5 will look artificially high (because they are getting the benefit of the van without showing any of the cost).

Instead, accounting spreads the cost of the van over the years it is used. We might charge ₹1,40,000 as a "Depreciation Expense" every year for five years.

• It ensures we calculate our true profit or loss for each specific year.
• It ensures our Balance Sheet shows the true, current value of our assets, not what we paid for them a decade ago.

What Does NOT Depreciate?

Depreciation applies to tangible fixed assets—things you can touch and feel, like machinery, furniture, vehicles, and buildings.

However, there is one major exception: Land. Land has an indefinite useful life. It does not suffer from wear and tear, and it cannot be destroyed by use. Therefore, in accounting, land is never depreciated. (In fact, land usually appreciates, meaning it goes up in value, though we generally do not record appreciation in standard historical-cost accounting until we sell it).

(Note: If an asset is intangible—like a patent, copyright, or software—the process of spreading its cost over time is called Amortization, not depreciation. If the asset is a natural resource like a coal mine or an oil well, the process of using it up is called Depletion.)

Worked Example: Bringing It All Together

Let us walk through a scenario that connects all these concepts.

The Setup: You run a wholesale electronics business.

1. 1On January 1st, you purchase a delivery scooter for ₹80,000 cash.
2. 2On February 1st, you sell ₹20,000 worth of electronics on credit to a retailer named Mr. Verma.
3. 3On December 31st, the financial year ends.

How the concepts apply:

• The Vouchers: When you bought the scooter, the dealership gave you a Cash Memo (Source Document). Your accountant prepared an Accounting Voucher to record the scooter as an asset. When you sold goods to Mr. Verma, you issued him a Sales Invoice (Source Document), proving he owes you ₹20,000.
• The Depreciation: On December 31st, you cannot say your scooter is still worth ₹80,000. You estimate it loses 10% of its value every year due to wear and tear. You record a Depreciation expense of ₹8,000 (10% of 80,000). The scooter's new book value is ₹72,000. No cash left your business for this ₹8,000 expense.
• The Insolvency & Bad Debt: In March of the next year, you hear that Mr. Verma's shop caught fire. He is ruined and is declared insolvent by the court. The court's receiver informs you that Mr. Verma's estate can only pay "30 paise in a rupee".
• Mr. Verma owed you ₹20,000.
• You receive 30%: ₹6,000 in cash.
• The remaining 70%: ₹14,000 is permanently lost. You record this ₹14,000 as a Bad Debt expense in your books.

Through vouchers, you proved the transactions happened. Through depreciation, you accurately tracked the falling value of your scooter. And through bad debts, you honestly recorded the loss from an insolvent customer. This is how accounting paints a true picture of a business's health.

Quick Revision

• Transaction: A financial event between parties that involves an exchange of value and can be measured in money.
• Voucher: The documentary evidence that proves a transaction occurred. It is the foundation of objective accounting.
• Source Document vs. Accounting Voucher: The source document is the raw bill/receipt; the accounting voucher is the internal form directing which accounts to debit and credit.
• Insolvency: A state where a person or business has more liabilities than assets and cannot pay their debts.
• Bad Debts: The amount owed by a debtor that cannot be recovered (usually due to insolvency). It is recorded as a business loss/expense.
• Paise in a Rupee: A term meaning percentage (e.g., 40 paise in a rupee = 40% recovery; the remaining 60% is a bad debt).
• Bad Debts Recovered: If a previously written-off bad debt is unexpectedly paid back later, it is treated as a new gain, not a credit to the old debtor's account.
• Depreciation: The gradual fall in the value of a tangible fixed asset due to wear and tear, passage of time, or obsolescence.
• Non-Cash Expense: Depreciation reduces profit but does not involve any actual cash leaving the business.
• Land: The one tangible fixed asset that is never depreciated, because it has an indefinite useful life.