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
| Particular | Amount | Amount |
| DEBTORS | 500000 |
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 | 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 | 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.