Provision for Doubtful Debts

by Rashi
(Ghaziabad, UP)

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 is a future loss (basically a liability).

In other words, doubtful debts or bad debts have already occured - the debt is bad right now. The provision, on the other hand, means 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.