In this business world, most of the transactions take place on credit rather than cash so the amount of risk involved is high. To minimize this risk many organization decides to allocate a certain portion towards provision for all the future expenses and losses. Provision is created because they accRead more
In this business world, most of the transactions take place on credit rather than cash so the amount of risk involved is high. To minimize this risk many organization decides to allocate a certain portion towards provision for all the future expenses and losses.
Provision is created because they account for particular company expenses and payments for the current year. This makes organization financial statements to look more precise. Provision is created from company profit to meet all the uncertain future obligations.
Meaning of Provision for Doubtful Debts-
The term provision for doubtful debts refers to the estimated (or) predicted value of bad debts that arises from the sundry debtors that have been issued but have turned out to be uncollectible. It takes place when a credit sale to the customer is made. Provision for Doubtful debt is a contra account and it is also known as Provision for bad debts.
Reason for creating Provision for Doubtful Debts-
In Accounting, Provision for Doubtful debts is created to abide with the conservatism convention and prudence principle which states that “don’t account for future anticipated profits but account for all possible losses”. Provision for Doubtful debts is an expense which occurs in the normal course of business.
Various organizations create a provision for all the future expected expenses and losses which may arise due to the credit sales so the organization needs to create a percentage of such provision on the net value of sundry debtor for complying with all the future uncertainties.
Example- ABC Ltd furnishes you with the following information about Total sales for the current accounting year
Particulars | Amount |
Total Sales | 6,00,000 |
Cash Sales | 2,00,000 |
Credit Sales | 4,00,000 |
Bad Debts | 40,000 |
The company decided to create 5% provision of doubtful debts on sundry debtors. Comment upon its decision.
Calculation of Provision for Doubtful Debts-
Step 1– Calculate Net value of sundry debtors
Net Sundry Debtors = Sundry Debtors – Bad Debts
= 4,00,000 – 40,000 => 3,60,000
Step 2 – Create 5% provision on net value of sundry debtors
Provision for Doubtful Debts = 3,60,000 * 5/100
= 18,000
The decision on creating a provision for doubtful debts will help the company to mitigate (or) reduce all the future obligations and uncertainties which arise due to the bad debts.
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Provision for Discount on Debtors The entity in order to encourage its customers to make a prompt payment allows a discount to its customers purchasing goods on credit. Thus, when the sales are made in the current reporting period on a credit basis the then the discount needs to be allowed in the neRead more
Provision for Discount on Debtors
The entity in order to encourage its customers to make a prompt payment allows a discount to its customers purchasing goods on credit. Thus, when the sales are made in the current reporting period on a credit basis the then the discount needs to be allowed in the next reporting period if such customer makes the payment promptly.
The discount allowed reduces the revenue of an entity and hence, it can be said that provision for a discount is expected loss for an organization and so it needs to be given effect in the current accounting period.
Calculation of Provision for Discount on Debtors
This can also be explained with the help of an example.
Illustrative Example
Calculate Debtors Balance to be shown in the Balance Sheet
Solution:
Aastha.
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