Provision for Bad /Doubtful Debt

When a company has a policy of selling goods on credit, a lot of times customers (receivables/ debtors)
end up not paying the amount they owe to the company. The amount deemed irrecoverable is recorded as
an expense and is referred to as a Bad Debt Expense.
The International Accounting Standards in accordance with the PRUDENCE concept states that a
provision for bad debts expense should be created on the basis of organizations past experience.
A business knows that the longer a debt goes unpaid, the more likely it will be uncollectible.
To ensure the final accounts meet the requirements of the prudence concept so that the results presented
present a true and fair view of the business’ financial position, as mentioned above, a provision for bad/
doubtful debts is created.
The prudence concept is an accounting concept that requires accounting professions to be cautious when
dealing with especially profits and assets, in that whenever there is a doubt in their values, they should be
understated, rather than overstated.
The provision for bad debts, also known as provision for doubtful debts, is the estimated amount of bad
debt that will arise from the trade receivables/ debtors over an accounting period. In other words, it is an
amount set aside from profits, to cover the debts of an accounting period that are not expected to be
paid.
The estimated may be a percentage of total credit sales or total trade receivables balance. The main logic
behind the creation of this provision is to accommodate the bad debts expense in the accounting period
which they relate.

Reasons for Provision for Bad/ Doubtful Debt

1. To charge s an expense in the profit and loss account as the amount that will never be paid
2. To show in the Balance Sheet, a debtors figure as close as possible to the true value of debtors at
the Balance Sheet date. (Net Realisable Value).

Accounting Entries for the Creation of a PFBD

1. Debit (Dr.) the Profit and Loss Account
2. Credit (Cr.) the Provision for Bad Debt Account
Eg.1: Creation of PFBD
On Dec 31. 2017, the debtors balance of V&R Ltd was $10,000. It was estimated based on the past
experiences that 2% of the debts ($200) will eventually prove to be bad. Being prudent, the accountant at
V&R Ltd decided to create a provision for bad debt for the estimated amount.

Accounting Entries:

Profit and Loss Account A/C

2017
$
Dec 31 Provision for Bad Debt 200

Provision for Bad Debts A/C

2017 2017
$ $
Dec 31 Bal c/d 200 Dec 31 Profit and Loss 200
200 200
2018
Jan 1 Bal b/d 200

Impact of Creation of PFBD on the Financial Statements:

The creation of a PFBD impacts both the Profit and Loss account and the Balance Sheet.

V&R Ltd
Profit and Loss Extract for the period ended Dec 31, 2017
Gross Profit xxxxx
Less Expenses:
Creation of Provision for Bad Debts 200
Rent xxx
Wages xxx

NB****** The amount used to CREATE the provision is an EXPENSE to the business
 V&R Ltd
Balance Sheet Extract as at Dec 31, 2017
$ $ $
Current Assets:
Stock xxxxx
Debtors 10,000
Less: PFDB (200) 9,800
Bank xxxxx
Expenses Prepaid xxxxx
Revenues Owing xxxxx
Cash xxxxx

NB******* The Provision for Bad Debt is deducted from the Debtors figure to arrive at the Net
Realisable Value.

Increase in the Provision for Bad Debts

Subsequent to the creation of the provision for bad debts, the estimated amount for uncollectibles may
increase.

Accounting Entries for Increase in the Provision for Bad Debts:

1. Debit (Dr.) the Profit and Loss Account
2. Credit (Cr.) the Provision for Bad Debts Account

Continuation of Eg.1: Increase in the PFBD

On Dec 31. 2018, the debtors balance of V&R Ltd was $12,000. It was estimated based on the past
experiences that 2% of the debts ($240) will eventually prove to be bad. As such, being prudent, the
accountant at V&R Ltd decided to maintain the provision for bad debt of 2% of outstanding debts.

Accounting Entries:
******NB. The amount BY which the provision account increases is an EXPENSE and is therefore
charged to the PROFIT and LOSS account
 Profit and Loss Account A/C

2018
$
Dec 31 Provision for Bad Debt 40

Provision for Bad Debts A/C

2017 2017
$ $
Dec 31 Bal c/d 200 Dec 31 Profit and Loss 200
200 200
2018 2018
Jan 1 Bal b/d 200
Dec 31 Bal c/d 240 Dec 31 Profit and Loss 40
240 240
2019
Jan 1 Bal b/d 240

Impact of Increase in the PFBD on the Financial Statements:

The increase in the PFBD impacts both the Profit and Loss account and the Balance Sheet.

V&R Ltd
Profit and Loss Extract for the period ended Dec 31, 2017
Gross Profit xxxxx
Less Expenses:
Increase in Provision for Bad Debts 40
Rent xxx
Wages xxx

NB****** The amount provision INCREASES BY is an EXPENSE to the business

 V&R Ltd
Balance Sheet Extract as at Dec 31, 2017
$ $ $
Current Assets:
Stock xxxxx
Debtors 12,000
Less: PFDB (240) 11,760
Bank xxxxx
Expenses Prepaid xxxxx
Revenues Owing xxxxx
Cash xxxxx

NB******* The Provision for Bad Debt is deducted from the Debtors figure to arrive at the Net
Realisable Value.

Decrease in the Provision for Bad Debts

Subsequent to the creation of the provision for bad debts, the estimated amount for uncollectibles may
decrease.

Accounting Entries for Increase in the Provision for Bad Debts:

1. Debit (Dr.) the Provision for Bad Debts Account
2. Credit (Cr.) the Profit and Loss Account

Continuation of Eg.1: Increase in the PFBD

On Dec 31. 2019, the debtors balance of V&R Ltd was $11,000. It was estimated based on the past
experiences that 2% of the debts ($220) will eventually prove to be bad. As such, being prudent, the
accountant at V&R Ltd decided to maintain the provision for bad debt of 2% of outstanding debts.
Accounting Entries:
******NB. The amount BY which the provision account decreases is an REVENUE and is
therefore charged to the PROFIT and LOSS account

Profit and Loss Account A/C

$ 2019
Dec 31 Provision for Bad Debt 20

Provision for Bad Debts A/C

2017 $ 2017
$
Dec 31 Bal c/d 200 Dec 31 Profit and Loss 200
200 200
2018 2018
Jan 1 Bal b/d 200
Dec 31 Bal c/d 240 Dec 31 Profit and Loss 40
240 240
2019 2019
Dec 31 Profit and Loss 20 Jan 1 Bal b/d 240
Dec 31 Bal c/d 220 ___
240 240
2020
Jan 1 Bal b/d 220

Impact of Decrease in the PFBD on the Financial Statements:

The increase in the PFBD impacts both the Profit and Loss account and the Balance Sheet.

V&R Ltd
Profit and Loss Extract for the period ended Dec 31, 2017
Gross Profit xxxxx
Add Revenues:
Decrease in Provision for Bad Debts 20
Less Expenses:
Rent xxx
Wages xxx

NB****** The amount provision DECREASES BY is an REVENUE to the business

 V&R Ltd
Balance Sheet Extract as at Dec 31, 2017
$ $ $
Current Assets:
Stock xxxxx
Debtors 11,000
Less: PFDB (220) 11,780
Bank xxxxx
Expenses Prepaid xxxxx
Revenues Owing xxxxx
Cash xxxxx

NB******* The Provision for Bad Debt is deducted from the Debtors figure to arrive at the Net
Realisable Value.