How to do provision for doubtful debts adjustment?

The provision for doubtful debts is the estimated amount of bad debts which will be uncollectible in the future. It is usually calculated as a percentage of debtors. The provision for a doubtful debt account has a credit balance and is shown in the balance sheet as a deduction from debtors. It is a contra asset account which means an account with a credit balance.

When a business first sets up a provision for doubtful debts, the full amount of the provision should be debited to bad debts expense as follows.

In subsequent years, when provision is increased the account is credited, and when provision is decreased the account is debited. This is so because provision for doubtful debts is a contra account to debtors and has a credit balance, and is treated as a liability.

Effects of Provision for Doubtful Debts in financial statements:

1. Trading A/c: No effect.
2. Profit and Loss A/c: Debited to P&L A/c and charged as an expense.
3. Balance Sheet: Deducted from Debtors.

For example, ABC Ltd had debtors amounting to Rs 50,000. It creates a provision of 5% on debtors.

Provision for Doubtful Debts = 50,000*5%

= 2,500

Journal entry for provision will be:

Effect on financial statements will be: