Provision for Doubtful Debts

Provision for Doubtful Debts:

An amount set aside out of profits to cover any outstanding debts, the recovery of which is in doubt. There are two main ways of calculating the amount of the provision.

They are:
•    by estimation based on past experience gained through knowledge of the particular business, its customers and the general economic business climate
•    by drawing up an ageing schedule of trade receivables

The bookkeeping entries to record the provision are:

Debit: Income statement Credit: Provision for doubtful debts 

Worked example
At the end of the first year of trading, Ann makes provision for doubtful debts at the rate of 5% on her trade receivables. Her outstanding trade receivables amount to £17 000. 

At the end of the second year of trading she increases the amount of the provision to 6% on outstanding debts of £23 000. At the end of her third year of trading she reduces the amount of the provision to 4% on outstanding debts of £14 000.

Required:
a.    The provision for doubtful debts account as it would appear in Ann’s general ledger. 

b.    Extracts from the income statements showing the amounts transferred at the end of each year from the provision for doubtful debts account.

Solution: