Some of the typical items which find a place in the profit and loss account of a firm are depreciation, bad debts and provisions. Enlisting these items on the debit side of the account is indicative of creating a charge on the profits of the firm for that period. If these items are not accounted for in the revenue statement for a period, it would hamper the true and fair view of the accounts. Let us study these concepts in detail.
A charge on the value of fixed assets of a firm, depreciation usually entails writing down the cost of a fixed asset. This is done in lieu of the matching concept of accountancy. There are two main methods of charging depreciation, which is the straight-line method and the written down value method.
Bad debts are those items of charge on the profits of the company that indicate the sums of money that could not be recovered from a debtor, during the year. In order to record the number of bad debts correctly, such sum is charged to the profit and loss account and deducted from the value of debtors for that year, so that the amount represents money that is actually expected to accrue from the debtors.
The journal entry passed to record the event is as follows:
Bad Debt Exp —————Dr
To Receivable Account —————-Cr
Provision for Doubtful Debts
The provision for doubtful debts is an estimated amount of bad debts that are likely to arise from the accounts receivable that have been given but not yet collected from the debtors. It is similar to the allowance for doubtful accounts.
Browse more Topics under Financial Statements
- An Introduction to Financial Statements
- Distinction between Capital Revenue and Capital Expenditure
- Operating Profit
- Trading and Profit and Loss Account
- Balance Sheet and Opening Entry
- Stakeholders and their Information Requirement
- Depreciation, Bad Debts and Provision for Bad and Doubtful Debts
- Need for Adjustment, Closing Stock and Outstanding Expenses
- Prepaid Expenses, Accrued Income and Income Received in Advanced
- Provision for Discount on Debtors, Managers Commission and Interest on Capital
- Manufacturing Account
Such provision is provided for, under accrual basis accounting, so that an expense is usually recognized for probable bad debts as soon as invoices are issued to customers, instead of waiting several months to find out exactly which invoices turned out to be stale.
Thus, the net impact of the provision for doubtful debts is to accelerate the recognition of bad debts into earlier reporting periods. The journal entry passed in this case will be as follows:
Provision for bad and doubtful debts A/c …. Dr
To Debtors A/c ………. Cr.
Solved Question for You
Q: ABC LTD has trade receivable of worth INR 50,000 as at 31 December 2010. XYZ LTD, a receivable owing INR 10,000 to ABC LTD at the year end, has been recently been wound up. Consequently, ABC LTD does not expect to recover the amount due from XYZ LTD.
Based on past experience, ABC LTD estimates that 5% of its receivables will default. An allowance for doubtful debts on 31 December 2009 appeared at INR 1500. ABC LTD must write off the INR 10,000 receivable from XYZ LTD as bad debt. Provide journal entries to record the events.
Answer: The journal entries will be as follows
Bad debt A/c – Dr. 10,000
To XYZ Ltd. 10,000
Allowance for doubtful debts A/c – Dr. 500
To Profit & Loss A/c 500