Difference between reserve and provision

1. Bad debts

   1. Accounting entries on bad debts:
      • Dr bad debts a/c
      • Cr debtors a/c
   2. Then at the end of accounting period:
      • Dr P&L
      • Cr bad debts

2. Discount allowed

   • Dr P&L
   • Cr provision for discount allowed

3. Treatment on provision for B.D.D

   1. In the first year:
      • Dr P&L
      • Cr provision for B.D.D
   2. Decrease in provision for B.D.D:
      • Dr provision for B.D.D
      • Cr P&L
   3. Increase in provision:
      • Dr P&L
      • Cr provision for B.D.D

A business starts on 1 January 20X2 and its financial year end is 31 December annually. A table of the debtors, the bad debts written off and the estimated bad debts at the rate of 2 per cent of debtors at the end of each year is now given. The double entry accounts and the extracts from the final accounts follow.

Solution

Sometimes, a debt written off in previous years is recovered. When this happens, you:

1. Reinstate the debt by making the following entries:
   • Dr debtor's account
   • Cr bad debts recovered account
2. When payment is received from the debtor in settlement of all or part of the debt:
   • Dr cash/bank
   • Cr debtor's account with the amount received

Some businesses create provisions for cash discounts to be allowed on the debtors outstanding at the balance sheet date. This, they maintain, is quite legitimate, as the amount of debtors less any doubtful debt provision is not the best estimate of collectable debts, owing to cash discounts which will be given to debtors if they pay within a given time. The cost of discounts, it is argued, should be charged in the period when the sales were made. While this practice is of dubious merit (as cash discount is treated as a finance charge, not as an adjustment to sales revenue), it is one used in practice by some businesses.

In a new business during the year ended 31 December 20X7 the following debts are found to be bad, and are written off on the dates shown:

• 31 May S Gill & Son £340
• 30 September H Black Ltd £463
• 30 November A Thom £156

On 31 December 20X8 the schedule of remaining debtors, amounting in total to £14,420, is examined, and it is decided to make a provision for doubtful debts of £410.

You are required to show:

1. The Bad Debts Account, and the Provision for Doubtful Debts Account.
2. The charge to the Profit and Loss Account.
3. The relevant extracts from the Balance Sheet as at 31 December 20X7.

Solution

A business had always made a provision for doubtful debts at the rate of 4% of debtors. On 1 January 20X8 the provision for this, brought forward from the previous year, was £320. During the year to 31 December 20X8 the bad debts written off amounted to £680. On 31 December 20X8 the remaining debtors totalled £16,800 and the usual provision for doubtful debts is to be made.

You are to show:

1. The Bad Debts Account for the year ended 31 December 20X8.
2. The Provision for Doubtful Debts Account for the year.
3. Extract from the Profit and Loss Account for the year.
4. The relevant extract from the Balance Sheet as at 31 December 20X8.

Solution

J Blane commenced business on 1 January 20X6 and prepares her financial statements to 31 December every year. For the year ended 31 December 20X6, bad debts written off amounted to £1,400. It was also found necessary to create a provision for doubtful debts of £2,600. In 20X7, debts amounting to £2,200 proved bad and were written off. J Sweeny, whose debt of £210 was written off as bad in 20X6, settled her account in full on 30 November 20X7. As at 31 December 20X7 total debts outstanding were £92,000. It was decided to bring the provision up to 4% of this figure on that date. In 20X8, £3,800 debts were written off during the year, and another recovery of £320 was made in respect of debts written off in 20X6. As at 31 December 20X8, total debts outstanding were £72,000. The provision for doubtful debts is to be increased to 5% of this figure.

You are required to show for the years 20X6, 20X7 and 20X8, the:

1. Bad Debts Account.
2. Bad Debts Recovered Account.
3. Provision for Doubtful Debts Account.
4. Extract from the Profit and Loss Account.

Solution