I think you should first understand what does the provision for doubtful debt mean and then understand the calculations of the same. Provision for Bad and Doubtful Debt Provision for bad and doubtful debt is a contra asset i.e it reduces the balance of an asset specifically the receivables. When anRead more
I think you should first understand what does the provision for doubtful debt mean and then understand the calculations of the same.
Provision for Bad and Doubtful Debt
Provision for bad and doubtful debt is a contra asset i.e it reduces the balance of an asset specifically the receivables.
When an entity executes transaction of sales on a credit basis it creates and adds on to the amount due from sundry debtors. These sundry debtors as per the agreed terms are liable to make a payment for such goods purchased before the end of the credit term.
If such debtor continuously makes a default such debtor shall be considered as a bad debt for the organization. When an entity remains doubtful regarding the recovery of its revenue i.e it has a reason to believe that such an amount due to be received may not be realised. Thus the entity shall create a reserve or a provision for doubtful debts.
The provision is created based on the entity’s past experience in the business and various other factors.
How is it calculated?
The table given below will help you to understand step by step calculations to compute provision for doubtful debts
| Particulars | Amount |
| Old Bad Debts (It shall be given in the Trial Balance on the Dr side) | XXXXX |
| Add New Bad Debts (It shall be given in the adjustment) | XXXXX |
| Add New Bad Debt Reserve (Debtors x %/100) (It shall be given in the adjustment) i.e (% of Debtors – New Bad Debts) | XXXXX |
| XXXXX | |
| Less Old Provision for Bad Debts (It shall be given in the trial balance on the credit side) | (XXXXX) |
| New Provision/Reserve for Bad Debts | XXXXX |
For Example,
Trial balance
| Particulars | Dr Amount | Cr Amount |
| Bad Debts | 400 | |
| Reserve for Bad Debts | 1500 | |
| Sundry Debtors | 16,000 |
Adjustment: Provide 2% reserve for bad and doubtful debts on the debtors. And it was realized that our debtor worth 1000 proved to be bad has been written off.
| Particulars | Amount |
| Old Bad Debts (Given in Trial Balance) | 400 |
| Add New Bad Debts (posted from adjustment) | 1,000 |
| Add New Bad Debt Reserve (Debtors x %/100) (It shall be given in the adjustment) i.e (% of Debtors – New Bad Debts) = (16,000 – 1,000) X 2 % | 300 |
| 1,700 | |
| Less Old Provision for Bad Debts (Giving effect to an adjustment) | (1500) |
| New Provision/Reserve for Bad Debts | 200 |
I have tried to put up both explanation and numerical example for you to understand how to compute Bad Debt Reserve hoping that it would be helpful for you.
Aastha Mehta.
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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
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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