If you have ever studied a balance sheet, you must have come across an item of provisions. It is listed on the liabilities side of the balance sheet. As easy as it sounds, it is not simple to understand the concept. You ought to understand this term and the purpose why we make use of it in accounts. Let us understand what provisions are.
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What is a Provision?
A provision is usually an amount that is set aside from a company’s profits, usually to cover an expected liability or a decrease in the value of an asset, even though the specific amount of the same might be unknown. A provision should not be understood as a form of savings, instead, it is a recognition of an upcoming liability, in advance.
Reserves, another common accounting term, and provisions are strictly not interchangeable terms. Whereas a provision is intended to cover upcoming liabilities, a reserve is a part a business’s profit, set aside to improve the company’s financial position through growth or expansion.
Browse more Topics under Depreciation Provision And Reserves
- Depreciation and Causes of Depreciation
- Methods of Calculating Depreciation Amount
- Straight Line Method and Written Down: A Comparative Analysis
- Methods of Recording Depreciation
- Disposal of Asset and any Addition or Extension to the Existing Asset
- Need for Depreciation and Factors Affecting Amount of Depreciation
- Reserves
- Declining Charge Method
- Other Methods
Providing a Provision in Accounting
In accounting terms, the matching principle states that the expenses should be ideally reported in the same financial year as the correlating revenues. This is because the costs that belong to a certain year can become misleading if accounted for in the previous or the future financial years.
Provisions, therefore, adjust the current year balance to be more accurate by ensuring that costs are recognized in the same accounting period as the relevant expenses. Provisions are recognized in the balance sheet and are also expensed on the income statement.
Types of Provisions in Accounting
The most common type of provision is a provision for bad debt. A provision for bad debt is one that has been calculated to cover the debts encountered during an accounting period that is not expected to be paid.
This provision is usually included in the budget which is created by a company and can be estimated based on past experience with bad debt amounts as well as industry averages. A general provision is not allowed as a tax deduction. A specific provision in which specific debts are identified is usually allowed as a tax deduction if there is documentary evidence to indicate that these debts are unlikely to be paid.
The Other common kinds of provisions in accounting include:
- Restructuring Liabilities
- Provisions for bad debts
- Guarantees
- Pension
- Depreciation
How can Provision be Created?
There are a number of factors that cause a company to create provisions. There are certain requirements that must be fulfilled before a financial obligation can be viewed as a provision. These include:
- The company must perform a reliable amount of regulatory measurement of the obligation.
- It must be probable that the obligation results in a financial drag on economic resources.
Solved Questions for You
Question: Through a journal entry, depict how a written off bad debt provision will be recorded in the books of accounts.
Answer – The entry is as follows,
| Bad debt expense A/c | Dr | 200 | |
| Â Â Â Â Â Â Â To Bad debt provision A/c | 200 |
Question: Pass a journal entry for the provision of Audit Expense for the year.
Answer: The journal entry is
| Audit Expense A/c – Dr. | Dr | 20,000 | |
| Â Â Â Â To Provision for Audit Expense A/c | 20,000 |
can we take certain/uncertain income in provision
Uncertain amount will be taken in provision. present obligation arising past event and second condition 50% probability and third amount will be perfect observation not randomly.
Tk. 50000 against audit and evaluation costs has been provisioned during 30th june 2019 whike settlement was made at actual taka 47500 as on 25th July 2019? please solve this journal..
On 30th June:
1. Audit expense a/c dr 50000
To Provision for Audit expense 50000
(Being Provision created for Audit expenses)
2. Profit and loss a/c dr 50000
To Audit expense a/c 50000
(Being Audit expense charged to Profit and loss a/c as an expense of
current year on accrual basis)
On 25th July, 2019:
1. Provision for Audit expense a/c dr 47500
To Cash/Bank 47500
(Being payment made towards Audit expense charged to the Provision
created previously)
2. Provision for Audit expense a/c dr 2500(i.e,50000-47500)
Profit and loss a/c 2500
(Being excess provision reversed by charging to Profit and loss a/c)
We have made provision for Bad Debts by debiting P&L during the year 2016-17. The debtors balance is still debit in our Books. How to make write off entry?
So interested to me