Provision for doubtful debts

• By the end of the lesson the learner should be able to:

• Explain the reasons for maintaining a provision for doubtful debts.

• Prepare ledger accounts and journal entries to record the creation

of, and adjustments, to, a provision for doubtful debts.

Starter activity :
• What percentage provision for
doubtful debts is the company
allowing in 2020?
 Provision for doubtful debts

• Why should financial statements of a business portray a “true and

fair view of the business’ profits and its assets and liabilities?

• A provision for doubtful debts is the estimated amount of the

proportion of trade receivables that may become irrecoverable
debts.
• The provision for doubtful debts is a trade receivable contra
account and therefore always has a credit balance.
• When the provision is made, the income statement is debited and
the provision for doubtful debts account is credited.
• The provision for doubtful debts should be made in the same
period that the debts for which the provision is made were
incurred, not in the year the debt became irrecoverable
 Provision criteria
• As the provision can only be an estimate, it is difficult to decide on the amount.
• The business could do one of the following to arrive at the amount of the
provision:
• Use past experience to estimate what percentage of trade receivables will not
pay.
• Look at each debt to determine whether it will be paid or not. A total is made of
any doubtful debts to arrive at the amount of the provision.
• Use an ageing schedule. As a rule, the older a credit sale is, the less
likely it will be paid for.

• Debts are sorted by age and a greater percentage of the older

debts are factored into the calculation of the provision, compared
to a lower percentage for the group with newer trade receivables.
Recording a provision for doubtful
debts
• Once the amount of the provision is decided on, the following
accounting entries should be posted:

• Debit: the income statement with the amount of the provision.

• Credit: the provision for doubtful debts account.
 general ledger
provision for doubtful debts account
Dr Cr
Date details $ Date details $

2018 2018
Aug 31 Balance c/d 134 Aug 31 Income statement 134

134 134
2018
Sep 1 Balance b/d 134
 Provision for doubtful debts
• (a) 20000x 0.03 = 600

• (b) 20000- 600 = 19400 x 0.03 = 582

 Irrecoverable debts in the trial
balance
• If irrecoverable debts are mentioned in the trial balance, it means
that they are already written off from the trade receivables figure
in the trial balance.
• if adjustments are to be made for both irrecoverable debts and
the provision for doubtful debts, they are mentioned in the
further information box after the trial balance.
Adjusting a provision for doubtful
debts
• Once a business has decided on a method of providing for
doubtful debts, usually a percentage of the trade receivables,
they may continue to provide for doubtful debts using the
same percentage.
• the value of trade receivables may change from year to year.
 Increasing the provision for
doubtful debts
• If for any reason, the business decides to increase the provision for doubtful
debts, adjustments are made to it at the end of the financial year as follows:
• The general journal entry is:
• Debit: the income statement with the increase in provision.
• Credit: the provision for doubtful debts account.
• The difference between the old provision and the new provision is added to
the expenses in the income statement.
 Income statement( extract)
as at 31 dec 2018
• Expenses :
• Increase in provision for doubtful debts $ 45

• Statement of financial position ( extract) as at 31 dec 2018

• Current assets:
• Trade receivables $ 4000
• Less provision for doubtful debts 200 $ 3800.
 Nominal Ledger
Jason Provision for doubtful debts account
Dr Cr
Date details $ Date details $
2019 2019
Dec 31 Balance c/d 300 Jan 1 Balance b/d 180

Dec 31 Income statement 120

300 300
2020
Jan 1 Balance b/d 300
 Income statement( extract) as at 31 Dec 2019

• Expenses: $
• Provision for doubtful debts 120
• Statement of financial position as at 31 dec 2019
• Current assets: Trade receivables 5000
• Less provision for doubtful debts 300 4700
 Decreasing the provision for
doubtful debts
• If, for any reason, the business decides to decrease the
provision for doubtful debts, adjustments are made to it at
the end of the financial year, as follows:
• The general journal entry is:
• Debit: the provision for doubtful debts account.
• Credit: the income statement with the decrease in provision.
• The difference between the old provision and the new
provision is to be added to the gross profit in the income
statement.

• The new provision is transferred to the statement of financial

position and is deducted, as usual, from trade receivables.
 Nominal ledger
Mary provision for doubtful debts account
Dr Cr
Date details $ Date details $
2018 2018
Dec 31 Income statement 100 Jan 1 Balance b/d 400
Dec 31 Balance c/d 300

400 400
2019
Jan 1 Balance b/d 300
 Income statement( extract) as at 31 dec 2018

• Gross profit : xx
• Add decrease in Provision for doubtful debts 100
Statement of financial position( extract) as at 31 dec 2018
Current assets:
Trade receivables 3000
Less provision for doubtful debts 300 2700