Accounting Treatment For The Increase Or (Decrease) Of Provision For Doubtful Debts

June 19th, 2006 Comments off
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INCREASE IN PROVISION FOR DOUBTFUL DEBTS:

Assuming earlier in Quarter 1, we have created a provision for doubtful debts of $100,000. Say,at end of Quarter 2, we have reviewed our trade debtors and wanting to increase the provision by an additional amount $50,000.

How should we do it ?

For Quarter 1,

The Original Entry is:

Debit : Provision for doubtful debt ( Income Statement)  100,000

Credit: Provision for doubtful debt ( Balance Sheet)        100,000

Being creation of provision for doubtful debts at Quarter 1.

 

In Quarter 2,

We increase the provision by an additional $50,000 namely:-

Debit: Provision for doubtful debt ( Income Statement)  50,000

Credit: Provision for doubtful debt ( Balance Sheet)       50,000

Being further increase in provision for doubtful debts at Quarter 2

 

Let’s look at the impact

From the Income Statement:-

For Quarter 1, Profit is lowered by $100,000

For Quarter 2, Profit is additionally lowered by $50,000

For Year To Date Quarter 2 : Overall profit is lowered by $100,000+$50,000 =$150,000

 

From the Balance Sheet :-

At Quarter 1:

Trade Debtors  $500,000 ( say)

Less:

Provision for doubtful debt  (100,000)

Net Trade Debtors  $400,000

 

At Quarter 2:

Trade Debtors  $500,000 ( say)

Less:

Provision for doubtful debt  (150,000) ( $100,000+50,000)

Net Trade Debtors $350,000

 

Based on the dual aspect concept, the creation of the additional provision will reduce the profit and also reduce the value of the asset which is the trade debtor.

In this case, with the increase in provision for doubtful debt, it results in an additional amount of $50,000  reduction in the Income Statement with a corresponding decrease in the Trade Debtors of the Balance Sheet. ( provision for doubtful debt shown in the debit side of the Balance Sheet as a reduction of Trade debtors

 

(DECREASE) IN DOUBTFUL DEBTS:

Assuming that during the quarter 2, some of these doubtful customers paid $80,000 .How do we treat it?

Scenario 1: If bad debts already being written off

As money is received and the bad debts have earlier been written off meaning that the trade debtors no longer exist in the books of accounts,

then we should:

Debit: Bank (money is received) $80,000

Credit: Bad Debts Written Off ( Income Statement)  $80,000

Being money received from earlier bad debts written off.

 

Scenario 2: Assuming that previously there is a general provision for doubtful being created

then we should:

Debit : Provision for doubtful debt (Balance Sheet)  80,000

Credit: Provision for doubtful debt ( Income Statement)  80,000

Being recovery of earlier provision for doubtful debt ( receipt of cash $80,000)

 

Let’s look at the impact

From the Income Statement:-

Assuming that earlier in Quarter 1, provision for doubtful debts of $100,000 is created hence reducing corresponding the profit by the same amount.

For Quarter 2, due to the receipt of cash from the doubtful debts, profit is now higher by $80,000 as this effectively reduce  the provision for doubt debts

For Year To Date Quarter 2 : the net Profit  $100,000-$80,000 =$20,000

 

From the Balance Sheet :-

At Quarter 1:

Trade Debtors  $500,000 ( say)

Less:

Provision for doubtful debt  (100,000) (say)

Net Trade Debtors  $400,000

 

At Quarter 2:

Trade Debtors  $500,000 ( say)

Less:

Provision for doubtful debt  (20,000) ( $100,000-80,000)

Net Trade Debtors  $480,000

 

To sum up, with money recovered from doubtful trade debtors, we can either:-

 

(1)  in the case of bad debts already written off, credit this money received as a credit to the bad debts written off in the Income Statement or

 

(2)  in the case of merely an earlier provision created without any write off, then we can credit the provision for doubtful debts in the Income Statement. Also, the money received will then be offset against the trade debtors ( not written off) and reflected in the bank account.

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