Provision for Doubtful Debts
Doubtful debts, as the name suggests, are those receivables which might become bad debts at some point in future. In other words, they are doubtful in recovery. By analyzing the past trend, a business can ascertain the approximate percentage that becomes bad every year out of the total credit allowed to buyers. This amount, thus estimated, is kept aside from the profits. This provision, made out of profits, is called Provision for Doubtful Debts.
Journal Entry to Create Provision for Doubtful Debts
|Profit & Loss A/C||Debit|
|To Provision for Doubtful Debts||Credit|
It is charged against current year’s profits.
Provision for doubtful debts is a liability for a business and is shown on the liability side of a balance sheet. Every year the amount gets changed due to provision made in the current year. Bad debts for the current year are to be set off and 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 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 (Add) New provision (Less) Old Provision