When an amount becomes irrecoverable from debtors the amount is debited to the Baddebts account and credited to the personal account of the debtors. But this is not sufficient. At the end of the year, the list of debtors may still contain some debts which are doubtful of recovery.

But the actual amount of bad debts relating to the current year would only be known in the next accounting year.

As such in order to ascertain the true profit of the current year provision called provision for doubtful debts is created out of the current year’s profit to provide for the possible bad debts which would be known in the next year.

Accounting treatment of Provision for bad debts

  • Profit and loss A/c Provision for bad debts is shown in profit and loss account.
  • Balance sheet: New provision for bad debts is deducted from Debtors in Balance sheet.

Provision for doubtful debts, on the one hand, is shown on the debit side of the Profit and loss account, and on the other hand, is also shown as a deduction from debtors on the asset side of the Balance Sheet.

 

Example of treatment of provision for bad debts.

The following information was given in Trail Balance

ParticularAmountAmount
DEBTORS500000 

Now we have to create provisions for bad debts @ 5% on debtors.
Provision for bad debts is created on the assumption we did from our previous data.

Answer :

Here 2% of 500000

will be 10,000

so it is assumed that 10,000 is irrecoverable.

we adjustment entry of need to pass at the end of the accounting year.

Particular

Amount

Profit and loss Account  a/c

10,000

   To provision for bad debts a/c

       10,000

(being provision for bad debts made)

Provision for bad debts in  Profit and Loss Accounts

Profit and loss Account for the year ending ….

Particular

Amount

Particular

Amount

To provision for doubtful debts

10,000

  

Balance sheet as on 31 march ….

Liability

Amount

Assets

Amount

 10,000

Debtors  500000

-Provision for
doubtful debts10000

490,000

Balance Sheet: Total amount of provision at year-end is deducted from trade receivables.

 In this example a new provision of Rs. 10,000 is made therefore it is known as New provision.

Now, this new provision is carried forward to next year and will be known as the old provision .and will be shown on the credit side of trial balance as on 31 March….

The actual amount of bad debt incurred in the last year will be deducted from this old provision. In the new year, the new provision is made again on debtors at a predetermined percentage which will be known as New provision.

Provision for bad debts given in Trial Balance

Trial balance as on 31 march …..

Particular

Amount

Amount

Provision for bad debts A/c

 

3000

Bad debts

2000

 

Debtors

200000

 

Now as provision for bad debts @ 2% on debtors is to made .

Note: here provision for bad debts for last year is given in trial balance is given.

It means we have to make new provision and also adjust it with old provision which is still with us.

New provision of 2% of 200000 which comes Rs 4000 .

Provision for bad debts A/c

2000

  To Bad debts

   2000

(being new provision for bad debts)

Pass it to show in profit and loss accounts.

Ledger of provision for bad debts

Particular

Amount

Particular

Amount

To Bal c/d

4000

by Bal B/d

3000

To Bad Debts A/c

2000

By profit and

loss

3000

 

 

  
 

6000

 

6000

Profit and loss A/c

Profit and loss A/c

3000

  To provision for bad debts a/c

   3000

(Being new provision for bad debts)

In profit and loss accounts.

Particular

Amount

Particular

Amount

To provision
for bad debts

3000

 

 

 

 

Here we showed 1000 in profit and loss accounts after doing adjustments in books.

In balance sheet.

Liabilities

Amount

Assets

Amount

  

Debtors -200000

-New provision 4000

-(2% of 200000)

196000

New provision is deducted from debtors in balance sheet.