Increase and Decrease in Provision of Doubtful Debts

Increase in Provision of Doubtful Debts

This sub-topic is exceptionally hard for most people but don’t give up, try reading this post!

The previous post was for businesses that start to open up provision account. During the first year, there is no need to worry about an increase or decrease in provision for doubtful debts. However, in any subsequent years, you will need to take note of three possible outcomes:

1) Increase in provision of doubtful debts
2) No change in provision of doubtful debts
3) Decrease in provision of doubtful debts

For e.g. last year, the debtors was $2,000.

Scenario 1: During the year, the debtors are $3,000. If you remember Step 1 in the previous post, we will need to calculate the provision of doubtful debts. In this case,

$3000 x 5% = $150

Now, compare this $150 with previous year of $100. There is an increase in provision for doubtful debts of $50.

Because the amounts of debts have increased, more bad debts will be expected in the future.

Okay, if this blurs you, imagine your friend borrowed $10 from you. You expected your friend to pay you back $8 dollars and as for the remaining $2, you gave up asking for it. Now, what if your friend borrowed $100 from you. You could have expected your friend to only pay you $80! Can you see the difference now? The bigger the amount you lend to your friend, the higher the amount will go to expecting bad debts (in this case, $20.) Can you also see that the increase in provision is $18?

An increase in provision for doubtful debts is an increase in expense. (Imagine that $18 of yours, isn’t that an expense?)

Credit Provision for Doubtful Debts Account.

Debit Profit and Loss Account.

In the Balance Sheet, include the provision for doubtful debts for the year, which is $150.

Decrease in Provision of Doubtful Debts

Scenario 2: The amount of debtors for the year totaled to $1000. The provision for doubtful debts is $50. Note: We are comparing with the $100 previous year, not with $150 in Scenario 1.

You can see that this year provision for doubtful debts have decreased by $50 (100-50.)  This decrease is an income for the business.

Blurred? Imagine your friend originally owe you $100, and you expect $20 as bad debts. Now that your friend paid you $50. You will expect that $10 will become bad debts and the other $10 was gone! Let that thoughts sink in for a bit first… can you see that the $10 (that is gone) becomes an imaginary gain because you are not losing that $10!

A reduction in provision for doubtful debts is an income to the business.

Debit Provision for Doubtful Debts Account.

Credit Profit and Loss Account.

In the Balance Sheet, include the current amount of the year.

No change in Provision for Doubtful Debts

This is very unlikely to happen because of the number of sales occurring in a year. You will always get a provision that is either higher or lower than the previous year. However, what if you just happened to get the exact same amount of debtors’ owing as the previous year? Answer is: You do nothing and move on!