Bad Debts and Doubtful Debts – SS2 Book Keeping Lesson Note (Second Term)

A provision for doubtful debts is an estimate of the part of the total debt owed by debtors that may not be collected. It is charged to the profit and loss account as an expense and deducted from debtors in the balance sheet. Adjustments of this kind are made at the end of the accounting period.

Behavioural objectives

By the end of the lesson, students should be able to:

• explain what a provision for doubtful debts is;
• state the entries for creating, increasing and decreasing a provision for doubtful debts;
• show where the provision appears in the balance sheet;
• list the items that require adjustments in final accounts.

What is a provision for doubtful debts?

Although a debt may not have become bad, there may be doubt as to whether it will be paid. It would be misleading to include that debt as an asset in the balance sheet as if the amount were not in doubt. On the other hand, since it has not yet become bad, it would be wrong to write it off. A provision is therefore made to cover such doubtful debt.

Provision for doubtful debts is a mere estimate of the total debt that may not be collected from the debtors. This estimated expense for bad debts, which cannot be calculated with substantial accuracy, is charged to the profit and loss account as an expense.

How do you create and maintain a provision for doubtful debts?

When the provision is first created, the full amount of the provision is entered. In the years that follow, the entries in the accounts are for increases or decreases in the amount required for the provision.

In all these cases, the provision for doubtful debts is deducted from the debtors in the balance sheet.

What are adjustments of the final accounts?

Adjustments are closing entries or amendments made in the books of accounts at the end of the accounting period to achieve a proper matching of costs and expenses with revenue.

Adjustments are required for the following:

1. Accruals
2. Prepayments
3. Depreciation of fixed assets
4. Provision for doubtful debts
5. Provision for discounts on debtors
6. Bad debts
7. Closing stock
8. Capital and revenue items of income and expenditure
9. Set-offs
10. Correction of errors, e.g. errors of omission, errors of principle, casting errors etc.
11. Provision for contingencies, e.g. legal charges and accountancy charges

Evaluation

1. What is a provision for doubtful debts?
2. State the entries made when a provision for doubtful debts is first created.
3. State the entries made when the provision is decreased.
4. Where is the provision for doubtful debts shown in the balance sheet?
5. Define adjustments in final accounts.

Assignment

1. List any five items that may cause adjustments in final accounts.
2. Outline any four factors that may make a debt irrecoverable.