Bad Debts, Provision for Bad Debts,
Debtors Control

by Anonymous
(South Africa)

Question:

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

Answer:

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

Bad Debts

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

For example, Joe Shmo, who owed you $1,000, 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 ..................... $1,000
Cr Sales .............................................. $1,000

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) ............... $1,000
Cr Debtors Control ........................... $1,000

Note that we could use "Accounts Receivable" instead of "Debtors Control" (same thing basically).

For US visitors, note that the journal entry for bad debts above is using what is known as the "Direct Write-Off Method" (as opposed to an alternate method called the "Allowance for Bad Debts" method).

Provision for Bad Debts

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 $200,000 in debtors control

(or accounts receivable). We expect 2% of debts owed to us to go bad in the future. This amounts to $4,000 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) .............................................. $4,000
Cr Provision for Bad Debts (like a liability) ....................... $4,000

T-Accounts

Here are what the T-accounts for the debtors control and 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 $196,000 ($200,000 - $4,000).

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."

Hope those explanations helped!

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

FYI I cover bad debts and provision for bad debts in a lot more detail in my accounting books, with full lessons, examples and exercises.

Best,
Michael Celender
Accounting Basics for Students

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

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Actual Bad Debts More than Provision for Doubtful Debts?
by: Anonymous

What journal entry must I record if actual bad debts are more than the provision for doubtful debts?

There is no automatic journal entry you pass in this situation (if that was what you were thinking).

One first simply records the entry for the actual bad debts.

Dr Bad Debts
Cr Debtors Control

Some managers in this situation would then consider increasing the provision for doubtful debts account as it is not reflecting what the bad debts are really coming to.

To do this we would record the usual journal entry to increase this provision:

Dr Bad Debts
Cr Provision for Doubtful Debts

Hope that makes sense!

Best,
Michael Celender
Founder of Accounting Basics for Students

Specific Provision for Doubtful Debts Subsequently Paid
by: Anonymous

What would be the double entry if a specific provision for doubtful debts which was made is paid in the next year?

The following year if you felt the provision needed to be lowered as the potential bad debt was now paid and future debts did not have the same likelihood of going bad, then you could cancel or reduce your provision.

However, if you felt there were other debts that could also go bad, you may want to leave it unchanged or even increase it.

If you chose to reduce/reverse the provision for bad debts then you would reverse the original entry where you created the provision.

The entry would be:

Dr Provision for Bad Debts (liability account)
Cr Bad debts (expense account)

Hope that helps!

- Michael

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