Provision for Bad Debts Meaning

Provision for bad debts is the estimated percentage of total doubtful debt that must be written off during the next year. It is done because the amount of loss is impossible to ascertain until it is proved bad. It is nothing but a loss to the company, which needs to be charged to the profit and loss account in the form of provision.

Please note that Debts can be classified into three categories which are:-

  • Bad Debts: These means which are uncollectable or irrecoverable debts.Doubtful debts: These means which will be receivable or cannot be ascertainable at the date of preparing the financial statements; in simple words, those debts are doubtful to realize.Good debts: These means which are not bad, i.e., neither there is the possibility of bad debts nor any doubt about their realization is known as good debts.

Journal Entries in Case of Bad Debt and Provision

In the First Year

  • For Bad debts

  • For provision for bad debts journal entries

In the Second/Subsequent Year

  • For Bad Debts

  • For Provision for Bad Debts Journal entries (If a new provision is more than the old)

Examples of Provision for Bad (and Doubtful) Debts Journal Entries

Below are the examples of provisions for a bad debt journal entry.

Example #1

  • As on 01.01.2012 Provision for Bad DebtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more is 5,000 ;As on 31.12.2012 Bad Debts written off is 3,000 & Sundry Debtors are 1,25,000;As on 12.2013 Bad Debts written off is 2,500 & Sundry Debtors are 1,00,000 ;Provision for doubtful debts to be provided for 5% for 2012 & 2.5% for 2013;Prepare Bad debts account and provision for bad debts account.

Bad debts Account

Provision for Bad debts Account

Example #2

M/s X Ltd. has a trade receivableTrade ReceivableTrade receivable is the amount owed to the business or company by its customers. It is also known as account receivables and is represented as current liabilities in balance sheet.read more of Rs. 10000 from M/s KBC as of 31.12.2018. Recently, a receivable owing to Rs. 1,000 to M/s X Ltd has been wound up. Consequently, M/s X Ltd. does not expect an amount to be recovered from M/s KBC.

Based on experience, M/s X Ltd. estimates that 3% of its receivables will do the default in making the payments. M/s X should write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more Rs. 1,000 from M/s KBC as bad debts. Please provide the journal entries to be made for bad debt. Note that the provision for bad debts on 31.12.2017 is Rs. 100.

The entries shall be made as under:-

(An allowance of Rs. 270 (i.e. (Rs. 10,000 – Rs. 1000) * 3%) should be made. A provision of Rs. 100 has already been created earlier. Therefore, only Rs. 170 shall be charged to the income statementIncome StatementThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more. )

 Example #3

Let’s assume that, in 2017, we need to create the provision for bad debts @ 15% of the sundry debtors, i.e., $ 1,00,000, as we expect that these debtors will not pay their dues.

So, in the first year, i.e., 2017, we shall pass the following journal entry for provisions of bad debt as under:-

At the end of 2018, we reviewed our sundry debtors, who were $ 1,10,000, and decided to provide the provision again at 15%. Accordingly, this year the provision will increase by $ 1,500 [($ 1,10,000 * 15%) – $ 15,000], and it shall be recorded in the books of accounts as under:-

At the end of 2019, we again reviewed our sundry debtors, who were $ 90,000, and decided to provide the provision again at 15%. Accordingly, this year the provision will decrease by $ 1,500 [($ 90,000 * 15%) – $ 15,000], and it shall record in the books of accounts as under:-

Based on the above, the following are the effects on the income statement:-

  • At the end of year 1:- Profit shall be lowered by $ 15,000At the end of year 2:- Profit shall be lowered by $ 1,500At the end of year 3:- Profit shall be increased by $ 1,500

Conclusion

Provision for bad debts can have a major impact on the financial statement of the companyFinancial Statement Of The CompanyFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more because it directly affects the profit and loss statement of the company, which is always required to give a true and fair view of the financial statements. Therefore, the estimation of the same should be made based on the company’s past performance.

This article has been a guide to Bad Debt Provision and its meaning. Here we discuss step-by-step examples of Provision for Bad Debts along with Journal entries and explanations. Here are the other articles in accounting that you may like –

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