Doubtful debt It is an estimate of how many debtors will not be able to pay in the future. The “Matching concept” requires that revenue be matched against related expenses for a specific accounting period. If there is a doubt about the recoverability of debt, it should logically become an expense. Then it should be matched against the sales of the accounting period that recognizes this revenue. From here the concept of estimating the bad debts arises. In this article we will discuss provisions for doubtful debt, how to calculate, and accounting provisions for bad debts.
Calculation of provision for doubtful debt
The principal accounting problem is to measure or estimate the amount of debtors who will not be able to pay in the future. There are three methods of estimating:
- Debt Review;
- Age analysis; and
- Percentage of Sales.
Debt Review:
Under this method, a sheet is prepared by considering each debt. In the sheet, debts are classified into:
- good debts; and
- doubtful debts.
Provision is the amount equal to the aggregate of doubtful debts.
Age analysis:
Under this method, We will calculate the age of all debtors and a higher rate of provision is applied to the old debtors as compared to the new ones.
Percentage of Sales:
Another method of estimating bad debt is based on sales. Under this method, a certain percentage is applied to sales for calculating provision.
(Bad debts (also known as irrecoverable debts or receivables)
A bad debt is an amount owed by a customer that the business believes it will never be able to collect. Examples of circumstances that might lead to the conclusion that a receivable is irrecoverable include:
- The bankruptcy or insolvency of a customer.
- The death of a customer who has left insufficient assets to pay off his debts.
- A dispute with a customer
- The dishonesty of a customer (where he has obtained goods on credit with no intention to pay).
Doubtful debts
A doubtful debt is an amount owed by a customer that the business believes might prove difficult to collect but they still hope to do so. For example, the business might know that the customer is in difficulty but that he might be able to work his way out of it. This casts doubt on the collectability of the receivable but it still might be possible if the customer can recover from his difficulties.
Examples of circumstances that might lead to the conclusion that a debtor is doubtful include:
- A customer is experiencing problems with cash flows.
- A customer takes an unusually long time to settle a debt.
- A customer is experiencing operational difficulties which might lead to financial problems (for example, strikes, natural disasters disrupting production, etc.).
Accounting for Provision for Bad Debts
Following is the account for the provision for doubtful debt. Its closing balance represents the e amount of future bad debt. Actual bad debts during the year will be transferred to this account. Putting opening balance expense for the year is a balancing figure.
For transferring bad debt to a provision account
Provision for doubtful debts Dr.
Bad debt Expense Account Cr.
Entry for creation of provision
Profit and Loss Account Dr.
Provision for doubtful debt Cr.
Frequently Asked Questions
What is the provision for doubtful debts for example?
The amount of bad debt expected to result from issued but uncollected accounts receivable is represented by the provision for debts. Subsequently, remove the particular customer invoice from the provision for dubious debts when you determine that it will not be paid.
Is provision for bad debts a liability?
We will report Bad debt as a business expense under sales and general administration expenses. On the balance sheet, however, We will list the bad debt and provision accounts as a contra-asset.
Is a provision a debit or credit?
We will record it on both sides debit and credit. A provision is debited as an expense and also credited to the corresponding liability account.
What is the journal entry for the provision for doubtful debts?
Journal entry for provision for doubtful debts is:
Provision for doubtful debts Dr.
Bad debt Expense Account Cr.