Bad Debts, Provision for Bad Debts, Debtors Control

by Anonymous
(South Africa)

Q: How does bad debts and the provision for bad debts affect the debtors control account?


A:
Let's make sure we fully understand what these terms are before I answer your question.

Bad debts are debts owed to the business that have become bad, meaning it seems they are uncollectable.

bad debtsFor example, Joe Shmo, who owed you R1,000 (R = Rands = South African currency), files bankruptcy and informs you of this. So it seems we won't get paid by Joe in future.

The original journal entry to record the sale would have been:
Dr Debtors Control R1,000
Cr Sales R1,000


When we become aware that someone won't pay us (that the debt has become 'bad'), we do an entry as follows:
Dr Bad debt (expense) R1,000
Cr Debtors Control R1,000


The provision for bad debts is not the same as bad debts.

The provision for bad debts is an estimate of the debts owed to us that will go bad in the future. We record this future loss of debts as soon as we are aware that we will definitely lose money in the future.

For example, let's say that at the end of the year we have R200,000 in debtors control. We expect 2% of debts owed to us to go bad in future. This amounts to R4,000 of our current debts. We're pretty sure we will lose this amount in the future. So we record this provision.

The entry to record this provision for bad debts is:
Dr Bad debts (expense) R4,000
Cr Provision for Bad Debts (like a liability) R4,000


Here are what the T-accounts for the debtors control and also the provision for bad debts would look like:

debtors control bad debts provision t-account

provision for bad debts t-account

As you can see, the provision for bad debts is kept as a completely separate account to the debtors control. These two accounts are, however, set off against one another in the balance sheet in order to present the true value of debtors. In our example above, the "Trade and other debtors" in our balance sheet would be shown as R196,000 (R200,000 - R4,000).

Note that the "provision for bad debts" is also known by a few other names, such as: the "allowance for doubtful debts," the "allowance for bad debts" or the "allowance for doubtful accounts."

See below for more comments, questions and answers on bad debts and the provision/allowance.

There are full lessons, examples and exercises on bad debts and provision for bad debts in my accounting books.

Hope that helps!

- Michael Celender
Accounting Basics for Students


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Comments for Bad Debts, Provision for Bad Debts, Debtors Control

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Question
by: Anonymous

Why do we debit p/l a/c while creating provision for bad debt????

With the provision we're recognizing we will lose some money in the future. Pro = forward, vision = to see ;-) .

We credit provision. We could just credit receivables/debtors account but in accounting generally we credit a separate provision account.

The debit to P/L account is an expense (bad debts). We recognize the expense immediately as we are sure we will lose money in the future.

Best,
Michael Celender

Provision for bad debts.
by: Anand John

Entries:

1) At the time of creating provision:
P/L Acc Dr
To Provision for Bad Debts Acc

2) For actual bad debts:
Bad Debts Acc Dr
To Debtors Acc

LOGIC BEHIND CREATING THE PROVISION
by: Anonymous

We create a provision in order to avoid uncertainty up to a certain amount and mentally prepare for that part of the debtors and in this way it is easy for us to plan for the contingency in that situation.

Use of Provisions
by: KARTHIK

In general words, provision means system to complete any work. But accounting provides another very technical definition of provision. In small business like shop, general store, there is no need to make any provision, so you will find minimum reference in basic accounting books but from time to time business expands and reaches the corporate level. It needs to understand the real meaning of provision and what is its importance and how can it be implemented in business accounting.

In very simple accounting term, "Provision is that action of business in which business organisation reserves his money for future losses for safeguarding business."

Benefits of Provisions
by: Anonymous

Can anyone please tell me the actual benefits of creating provisions?

The main benefit of creating a provision is simply that it more accurately represents the value of debts owing to your company.

For example, if you have a debtors account to the value of $300,000, but you realistically expect that some of this may not be received (which is the usual case in business), then you can create a provision for bad debts.

You can choose this to come to 2% of the debtors. 2% X $300,000 = $6,000.

Therefore debtors as shown in the balance sheet will actually come to $294,000 ($300,000 - $6,000). This is a more accurate representation of the real value of the debtors.

If you are a public company that is required to produced audited financial statements then you will most probably have to create a provision. If you are a small business where you don't have a requirement of producing audited financial statements then provisions are optional but recommended.

- Michael
Accounting Basics for Students

Provision for Bad debt
by: Anonymous

Creation entry for provison for Bad debts is

Profit& loss a/c Dr
To Provision for Bad debt a/c

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