Provision for Doubtful Debts

08/01/2022 0 By indiafreenotes

The provision for doubtful debts is the estimated amount of bad debt that will arise from accounts receivable that have been issued but not yet collected. It is identical to the allowance for doubtful accounts. The provision is used under accrual basis accounting, so that an expense is recognized for probable bad debts as soon as invoices are issued to customers, rather than waiting several months to find out exactly which invoices turned out to be uncollectible. Thus, the net impact of the provision for doubtful debts is to accelerate the recognition of bad debts into earlier reporting periods.

Accounting for the Provision for Doubtful Debts

A business typically estimates the amount of bad debt based on historical experience, and charges this amount to expense with a debit to the bad debt expense account (which appears in the income statement) and a credit to the provision for doubtful debts account (which appears in the balance sheet). The organization should make this entry in the same period when it bills a customer, so that revenues are matched with all applicable expenses (as per the matching principle).

Later, when a specific customer invoice is identified that is not going to be paid, eliminate it against the provision for doubtful debts. This can be done with a journal entry that debits the provision for doubtful debts and credits the accounts receivable account; this merely nets out two accounts within the balance sheet, and so has no impact on the income statement. If you are using accounting software, create a credit memo in the amount of the unpaid invoice, which creates the same journal entry for you.

It is highly unlikely that the provision for doubtful debts will always exactly match the amount of invoices that are actually unpaid, since it is only an estimate. Thus, you will need to adjust the balance in this account over time to bring it into closer alignment with the ongoing best estimate of bad debts. This can involve an additional charge to the bad debt expense account (if the provision appears to initially be too low) or a reduction in the expense (if the provision appears to be too high).

Presentation of the Provision for Doubtful Debts

The provision for doubtful debts is an accounts receivable contra account, so it should always have a credit balance, and is listed in the balance sheet directly below the accounts receivable line item. The two-line items can be combined for reporting purposes to arrive at a net receivables figure.

Profit & Loss A/c Debit
To Provision for Doubtful Debts Credit

Provision for doubtful debts acts as a liability for the business and is shown on the liability side of a balance sheet. Every year the amount gets changed due to the provision made in the current year. Bad debts for the current year are to be set off, and an additional amount of provision is to be added.

When certain bad debts are to be written off and a provision for doubtful debts is to be made, the amount should be first debited against the existing balance of provision and the remaining balance in the account should be brought up to the required figure.

This can be easily understood as:

The calculation in the case where bad debts occurring in the following year have to be adjusted and an additional amount of provision is to be made, the calculation should be done in the following sequence:

=Bad debts + New provision – Old Provision