BAD DEBTS AND PROVISION FOR DOUBTFUL DEBTS

Bad debts

The amount of the debtors which cannot be recovered is known as bad debt. At the end the accounting year, the amount of bad debt is shown as an expense in the profit & loss account and deducted from the debtors. The double entry for recording the bad debt is:

                                Debit Bad debt account

                                Credit Debtors account

At the end of the year, while preparing the final accounts, the bad debt account is transferred to the profit & loss account by passing the following adjustment entry:

                                Debit Profit & loss account

                                Credit Bad debt account

Provision for bad debts (Provision for doubtful debts)

The provision created to cover the next year’s bad debt expense out of the current year’s debtors is known as provision for bad debts. This provision is created on the debtors after deducting the current year’s bad debt. The double entries required for creating the provision for bad debt are:

                First year               Debit      Profit & loss account and

                                                Credit     Provision for bad debts account.

               

Second year and subsequent years:

               

                For an increase in the provision for bad debt:

                                                Debit      Profit & loss account and  (with the amount increased)

                                                Credit     Provision for bad debts account.

                For a decrease in the provision for bad debt:

                                                Debit      Provision for bad debt account and

                                                Credit     Profit & loss account

The amount of decrease in the provision for bad debt is shown as an income in the profit and loss account

While preparing the balance sheet, always the new provision for bad debt is deducted from the amount of debtors.

Provision for discount on debtors

This is the provision created to cover the expense of discount that may be allowed to the debtors during the coming year when they pay their debt on time. The increase in the provision for discount on debtors is also shown as an expense in the profit & loss account and the new provision for discount on debtors is deducted from the debtors in the balance sheet.

The amount of provision for decrease in the provision for discount on debtors is shown as an income in the profit & loss account.

The double entries required for the provision for bad debt are:

                During the first year to create the provision for discount on debtors:

                                Profit & loss account                                                          Dr

                                Provision for discount on debtors account                     Cr

During the subsequent years, for an increase in the provision for discount on debtors:

                                Profit & loss account                                                          Dr.

                                Provisions for discount on debtors account                   Cr. 

                For a decrease in the provision for discount on debtors:

                                Provisions for discount on debtors account                   Dr.

                                Profit & loss account                                                          Cr.

Key points

• A debt written off is recorded in the books by debiting bad debts account and crediting debtors account.
• The provision for bad debt is calculated on the debtors’ balance obtained after deducting the bad debt written off.
• In the balance sheet, always the new provision for bad debt is deducted from the Debtors.
• Increase in the provision for bad debt is debited in the profit & loss account and credited in the provision for bad debt account.
• Decrease in the provision for bad debt is credited to profit & loss account and debited in the provision for bad debt account.
• Increase in the provision for bad debt is an expense and decrease in the provision for bad debt is an income to be shown to in the profit & loss account.
• The provision for discount on debtors is calculated on the debtors balance after deducting the bad debt and the provision for bad debt amount.
• Always new provision for discount on debtors is deducted from debtors, after deducting the provision for bad debt.
• Increase in the provision for discount on debtors is debited to profit & loss account and credited to provision for discount on debtors account.
• Decrease in the provision for bad debt is debited to provision for discount on debtors account and credited to profit & loss account.
• Increase in the provision for discount on debtors is an expense and decrease in the provision for discount on debtors is an income to be shown in the profit & loss account.