Final Accounts – Provision For Doubtful Debts

PROVISION FOR DOUBTFUL DEBTS

Although a debt may not actually have become bad, there may be doubt as to whether it will be paid. It would be misleading to include that debt as an asset in the balance sheet pretending that the amount is not in doubt. On the other hand, since it has not yet become bad, it would be wrong to write it off. A provision is therefore made to cover such doubtful debt.

Provision for doubtful debt is a mere estimate of the total debt that may not be collected from the debtor. This estimated expense for bad debts which cannot be calculated with substantial accuracy is charged to the profit and loss account as an expense.

HOW TO CREATE AND MAINTAIN A PROVISION FOR DOUBTFUL DEBTS

A. When the provision for doubtful debt is first created;
Debit Profit and Loss Account
Credit Profit for doubtful debts Account
with the full amount of the provision
In the years that follow, the entries in the accounts will be for increases or decreases in the amounts required for the provision.

B. INCREASING THE PROVISION FOR DOUBTFUL DEBTS
Debit Profit and Loss Account
Credit Profit for doubtful debts Account
with increases in the provision.

C. DECREASING THE PROVISION FOR DOUBTFUL DEBTS
Debit Profit for doubtful debts Account
Credit Profit and Loss Account
with decreases in the provision.
In all the instances (A-C) as described above, the provision for Doubtful Debts is deducted
from the Debtors in the Balance Sheet.

EVALUATION

1. Explain the following terms:
   (a) Bad debts (b) Provision for doubtful debts
2. List three types of provisions that could give rise to adjustments in the final accounts.

EVALUATION

1. Differentiate between provision for bad debts and provision for depreciation.
2. List two characteristics of provisions in financial accounting.

GENERAL EVALUATION
1 State five differences between cash discount and trade discount
2 Identify any seven prime books of account and highlight the uses of each ofthem where necessary
3 List five advantages of using the imprest system to record petty cash transactions
4 Explain the following types of errors (a) omission (b) principle (c) commission (d) original entry (e) complete reversal of entry (f) compensating error
5 Explain how the following items are treated in Profit and Loss Account and Balance
Sheet (a) provision for doubtful debts (b) bad debts recovered

READING ASSIGNMENT
Simplified and Amplified Financial Accounting Page 143-150

WEEKEND ASSIGNMENT

1. A decrease in the provision for doubtful debts results in _
   (a) an increase in net profit (b) a decrease in gross profit (c) an increase in gross profit (d) a decrease in net profit
2. The term bad debts means debt __
   (a) recorded in a wrong account (b) owed by an employee (c) paid with fake currency (d) that cannot be collected again from the debtor
3. The gross profit for a trading period is calculated as _
   (a) Net sales less net purchases (b) Net sales less cost of sales (c) Net sales less closing stock (d) Net sales plus cost of goods sold
   Use the information below to answer questions 4 and 5
   N
   Provision for bad debts 1,000 Cr
   Bad Debts 500 Dr
   Debtors 50,000 Dr
   Additional bad debts to be written off 500
   New provision for bad debts to stand at 5% of debtors.
4. In the balance sheet the net figure for debtors is __
   (a) N47,025 (b) N46,550 (c) N45,600 (d) N43,225
5. The total amount of bad debts to be charged as expenses in the profit and Loss Account is _
   (a) N2,000 (b) N1,500 (c) N1,000 (d) N500

THEORY
Mr. Okonkwo’s books of account shows the information for four years ended 31st December, 2000. The balance of debtors and bad debts were given for the four years.
Debtors Bad
Balance Debts
N N
31st December, 1997 40,000 2,000
31st December, 1998 30,000 1,000
31st December, 1999 50,000 2,500
31st December, 2000 60,000 3,000
Provision for doubtful debts brought forward at 1st January, 1997 was N600.
Mr. Okonkwo makes provision for doubtful debts at the rate of 10% on total debtors outstanding after deducting bad debts for the period.

You are required to prepare the following accounts for the years ended 31st December, 1997, 1998, 1999 and 2000.
(a) Bad Debts Account
(b) Provision for doubtful debts Account
(c) Profit and Loss Account
(d) Balance Sheet (extract)