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The business might not determine that a debtor is unable to pay until the next period following the credit sales. As such if we use the direct write off method the revenue and assets will be overstated in the year of sale and understated the following year when it is determined the debtor will not pay. To overcome this problem, the common method accounting for bad debts is to create a provision at balance date we expect debtors will be unable to pay. The accountant has techniques for estimating the amount of expected uncollectible accounts, even though it is not possible to determine which debtors will not pay. Accountants use a number of methods to estimate the amount expected for bad debts. eg taking a percentage of credit sales based on previous years. It is important to note that a a provision account does not represent a liability, it is not a future disposition of economic benefits the business is obliged to make. It is a negative or contra asset because the amount of the provision for doubtful debts should be deducted from the debtors to provide us with the net amount of future economic benefits we expect to obtain from our debtors.
I agree with my colleagues . However, we can say yes we have a formula for the calculations of the bad debts and doubtful accounts. It depends on the aging reports that being made for the company for the AR of our customer, and then your estimation of the collection as we always have a history with all customers. Then all that to be completed into percentages. and then we can estimate the number and make the entries.
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Assalam Alecum
Bad Debts Provision is not a formula , its a probable decision of a company.
So Every company has its own provision according to his recovery & commitments
Bad Dabt Expense
Provision for Bad Debts
If Recover in future
Provision for Bad Debts
Bank / Cash
Recover-ability of some receivables may be doubtful although not definitely irrecoverable. Prudence requires that an allowance be created to recognize the potential loss arising from the possibility of incurring bad debts.
Following should be the basis to calculate/estimate provision for doubtful debts:
1. Receivables ageing method- ageing and its decision on recover-ability purely depends upon the nature of industry. It may very industry to industry. This should be adopted in combination of review of past trend of collection from & financial strength of customers individually;
2. Percentage of sales method - It is calculated based on a predetermined % of credit sales. The percentage may be derived based on historical facts;
3. Receivables balance method- derived as a percentage of outstanding receivables at the cut-off date.
The allowance for doubtful debts is created by forming a credit balance which is deducted from the total receivables balance in the financial statement through the journal entry as below:
Provision for Doubtful Debts (Expense) Dr
Doubtful debts provision (Balance Sheet) Cr
Actually Bad Debts are calculated based on the financial condition of customers,some are going to liquidate, also based on industry in which it operates,may be industry is volale & based on competitor evaluations on provision or industry average.
It is named as provision means uncertain outcome in probable future.
So, receivables may not pay amount. So in advance company estimates a %age of sales as provision of Doubtful Debts.
Entry: Bad Debts DR Provision CR
After end of year, If some pay back then reverse the entry to that amount.
bad debts should be debited in current year profit & loss account , traial balance provision referes to provision for bad debts for this year and which is created previous year.new provision means provision for next year which have to make this year and deducted this amount from account receivables(debtors)in balance sheeet.If old provision amount is excess amount than actual bad debts then only deduct balance amount from debtors for making new provision provision amount would be treated as liability in balancesheet under the head current liability and provision and debit profit and loss account for eg; In case provision amount is1000 as per company policy old provision1000 bad debts800 deductable amount from account receivables this year=new provision-(old provision-bad debts)1000-(1000-800) =1000-200 =800
the journal entry as below:
Provision for Doubtful Debts (Expense) Dr
Doubtful debts provision (Balance Sheet) Cr
