Question

Question : What are 'provisions'? How are they created? Give accounting treatment in case of provision for doubtful debts.

Answer 1

Provision can be explained as an arrangement for certain types of expenses/losses which are related to the current accounting period but amount of which is not known with certainty because they are not yet incurred. It is necessary to make provision for such items for ascertaining true net profit.

E.g. A trader who sells on credit basis knows that some of the debtors of the current period would default and would not pay or would pay only partially.
It is necessary to take into account such an expected loss while calculating true and fair profit/loss according to the principle of Prudence or Conservatism.

Therefore, the trader creates a provision for doubtful debts to take care of expected loss at the time of realization from debtors. In a similar way, provision for repairs and renewals may also be created to provide for expected repair and renewal of the fixed assets. Examples of provisions are
(i) Provision for depreciation
(ii) Provision for bad and doubtful debts
(iii) Provision for taxation
(iv) Provision for discount on debtors
(v) Provision for repairs and renewals
Accounting Treatment for Doubtful Debts : First of all the amount of expected bad debts is ascertained which is posted in the debit side of P & L Account as new provision for doubtful debts is greater than new one, it will be shown in the credit side of P & L account and if the new provision is greater than the old one, the balance amount will be shown in the debit side of the P & L account. After that the amount of new provision will be deducted from the debtors figure in assets side of the balance sheet.