Bad debt provision-Meaning,Understanding,Examples (Commerce Achiever)

Bad debt provision is reserve made to show the estimated percentage of the total bad and doubtful debts that needed to be written off in the next year and it is simply a loss because it is charged to profit & loss account of the company in the name of provision.

Provision for Bad Debts Meaning

Please note that Debts can be classified into three categories which are as under:-

• Bad Debts: It means which are uncollectable or irrecoverable debts.
• Doubtful debts: It means which will be receivable or cannot be ascertainable at the date of preparing the financial statements, in simple words those debts which are doubtful to realize.
• Good debts: It means which are not bad, i.e., neither there is the possibility of bad debts nor any doubt about its realization is known as good debts.

In the First Year

• For Bad debts

• For provision for bad debts journal entries

In the Second/Subsequent Year

• For Bad Debts

•  For Provision for Bad Debts Journal entries (If a new provision is more than old)

Below are the examples of provision for a bad debt journal entry.

Example #1

• As on 01.01.2012 Provision for Bad Debts is 5,000 ;
• As on 31.12.2012 Bad Debts written off is 3,000 & Sundry Debtors are 1,25,000;
• As on 12.2013 Bad Debts written off is  2,500 & Sundry Debtors are 1,00,000 ;
• Provision for doubtful debts to be provided for 5% for 2012 & 2.5% for 2013;
• Prepare Bad debts account and provision for bad debts account.

Bad debts Account

Provision for Bad debts Account

Example #2

M/s X Ltd. has a trade receivable of Rs. 10000 from M/s KBC as on 31.12.2018. Recently, a receivable owing to Rs. 1,000 to M/s X Ltd has been wound up. Consequently, M/s X Ltd. does not expect and amount to be recovered from M/s KBC.

Based on past experience, M/s X Ltd. estimates that 3% of its receivable will do the default in making the payments. M/s X should write off Rs. 1,000 from M/s KBC as bad debts. Please provide the journal entries to be made for bad debt. Note that provision for bad debts as on 31.12.2017 is Rs. 100.

The entries shall be made as under:-

(An allowance of Rs. 270 (i.e. (Rs. 10,000 – Rs. 1000) * 3%) should be made. A provision of Rs. 100 has already been created earlier. Therefore, only Rs. 170 shall be charged to the income statement. )

 Example #3

Let’s assume that, in the year 2017, we need to create the provision for bad debts @ 15% of the sundry debtors, i.e., $ 1,00,000 as we are expecting that these debtors will not pay their dues.

So, in the first year, i.e., 2017, we shall pass the following journal entry for provisions of bad debt as under:-

At the end of 2018, we reviewed our sundry debtors which were $ 1,10,000 and decided to provide the provision again at 15%. Accordingly, in this year the provision will increase by $ 1,500 [($ 1,10,000 * 15%) – $ 15,000], and it shall be recorded in the books of accounts as under:-

At the end of 2019, we again reviewed our sundry debtors which were $ 90,000 and decided to provide the provision again at 15%. Accordingly, in this year the provision will decrease by $ 1,500 [($ 90,000 * 15%) – $ 15,000], and it shall record in the books of accounts as under:-

Based on the above, the following are the effects on the income statement:-

• At the end of year 1:- Profit shall be lowered by $ 15,000
• At the end of year 2:- Profit shall be lowered by $ 1,500
• At the end of year 3:- Profit shall be increased by $ 1,500

Provision for bad debts can have a major impact on the financial statement of the company because it directly affects the profit and loss statement of the company, which is always required to give a true and fair view of the financial statements. Therefore, the estimation of the same should be made based on the past performance of the company.