Provision for Doubtful Debts

Wherever goods are sold on credit basis there are chances that some amounts would not be recoverable.The trade debts where there are doubts as to whether those will be recovered or not are called Doubtful Trade Debts. At every reporting date, management needs to identify good and doubtful trade debts and a provision is recorded against doubtful trade debts under the prudence concept. The provision is then evaluated at each subsequent reporting date for adequacy.

Bad debts (if any) are written off immediately on identification.

Example:

A company has trade debts at end of year 2015 amounting to Rs. 1,000,000. Management estimates that recovery of trade debts worth Rs. 200,000 is doubtful and estimates a 50% chance of recovery in case of doubtful debts.

In this example management needs to recognize provision for doubtful debts amounting to Rs. 200,000 x 50% = Rs. 100,000 through following entry.

The trade debts would be reported in balance sheet net of the provision as follows:

During the year 2016, let’s assume debts amounting to Rs. 80,000 are confirmed as non-recoverable. The entry would be recorded as below:

At the end of year 2016, let’s assume trade debts amount to Rs. 1,200,000 with doubtful debts amounting to Rs. 300,000 with a 50% chance of recovery in case of doubtful debts. Now management needs a year end provision for doubtful debts of Rs. 150,000 (i.e. Rs. 300,000 x 50%), however, provision for doubtful debts account already contains a balance of Rs. 20,000 (Rs. 100,000 – 20,000) so new provision will be recorded for the balancing amount of Rs. 130,000.

The trade debts at the end of year 2016 would be reported in balance sheet net of the provision as follows: