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Provision for Doubtful Debts
Q: Hi! I'm rashi doing CS and my question is:
State with reason/s whether this statement is true or false. A provision for doubtful debts is created on debtors who are definitely bad.
A: Good question Rashi. A provision is a loss or expense that will definitely occur in the future, but we don't know exactly how much or when the loss/expense will occur.
Usually a business decides (based on past records) that they expect a certain percentage of their debtors (receivables) not to pay them next year. Let's say it's 5%. If their debtors come to $100,000, then they expect $5,000 to go "bad," and the real (net) debtors in their records will be $95,000 ($100,000 - $5,000).
The provision for doubtful debts (or bad debts) is different to doubtful debts (or bad debts).
Doubtful debts (or bad debts) is an expense and has already occurred.
The provision for doubtful debts is a future loss (basically a liability).
In other words, doubtful debts or bad debts have already occurred - the debt is bad right now.
The provision, on the other hand, is for debts that will definitely occur but in the future. The debts are not bad yet, but we are sure they will be bad. It is an estimate of bad debts in the future.
Hope that answers your question.
Please note that I don't have detailed lessons, examples and exercises for provision for bad debts (and bad debts) on this site really. This is only available in my basic accounting books.