PROVISIONS FOR BAD AND DOUBTFUL DEBTS

1.0 INTRODUCTION

Once a business decides to sale its goods or services on credit, it is bound to have three types of debtors: good, doubtful and bad. Good debtors are the dream of any business, since they are those debtors that are guided by their conscience and honor; as they buy on credit, they are determined to pay back on or before the maturity date. Doubtful debtors need some incentive/motivation before they effect payment on purchases made on credit, while bad debtors need to be written off the accounts when confirmed to be such! This Unit attempts an overview of these types of debtors and discusses how they are to be treated in the books of accounts of any serious business organization.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1. appreciate the type of debtors a business may have in its accounts 
2. adjust for bad and doubtful debtors in the books of accounts 
3. adjust for drawings made by a business proprietor 
4. treat for stock value in the final accounts. 

3.0 MAIN CONTENT

3.1 Provisions for Bad and Doubtful Debts

3.2 Bad Debts

These are debts which are found to be irrecoverable. If detected before drafting the trial balance, they should simply be posted as expenses to the profit and loss account and no more. But where such losses are detected after drafting the trial balance, the amount so detected is posted as an expense to the profit and loss account and deducted from the debtors balance in the balance sheet.
DR: Bad Debt Account
CR: Debtor’s Account

The bad debt account is to be closed to the profit and loss account, as an expense.

Where a debt already written off as bad is recovered in whole or in part in subsequent period, the entries required are:

DR: Cash/Bank Account
CR: Bad Debt Recovered Account

The bad debt recovered account is to be closed to the profit and loss account, as a gain.

3.3 Doubtful Debts

These are debts on which the creditor is uncertain as to their recoverability. The debtor might be willing but unable to pay, or able but unwilling to pay as on the maturity date. To be prudent, an estimate is to be made on the percentage value of such debtors and provision made against them out of the expected profit of the business. The amount provided is to be deducted from the total value of debtors and charged to the profit and loss account.

3.3 Provision

This refers to the commitment made out of profit on the likely diminutions in the value of an asset or for any known liability for which the amount involved cannot be determined with substantial accuracy.
Provisions commonly found in the profit and loss account of a business are:

1.  Provision for doubtful debt; 
2. Provision for discount on debtors; and 
3.  Provision for depreciation. 

Under this heading we shall discuss I and II only as III would be adequately discussed in Unit 4.

a) Provisions for Doubtful Debts

This is provision made out of profit to meet debt which is likely to turn bad. It is usually provided for after all debt which is known to be irrecoverable has been written off. A provision for doubtful debt may be calculated either by:

1. Reference to the amount of the specific debt (specific provision for bad debt); 
2. As a percentage of the total debt outstanding after deducting irrecoverable one (general provision for doubtful debt). 

In practice, the percentage most likely to turn bad is arrived at based on the debtor(s) history. This percentage therefore constitutes the rate which shall be used in providing for doubtful debts and those not fluctuating widely.
The Accounting entries required for recording provisions for doubtful debts are:
DR: Bad debt account
CR: Provision for doubtful debts account

To create provisions for doubtful debts; bad debt account is to be closed to the profit and loss account, while provision for doubtful debt account is to be closed to the balance sheet.
DR: Provision for doubtful debts account
CR: Profit and loss account

With a decrease in the provision for doubtful debts

The provision for doubtful debts (closing balance) is deducted from the debtors balance in the balance sheet to ascertain the net good debtors.

b) Provision for discount on debtors

This provision is allowed on good debtors and it is usually based on a fixed percentage of good debtors i.e. debtors less bad debt less provision for doubtful debts. The account is provided in a similar manner as that of provision for doubtful debts.

SELF ASSESSMENT EXERCISE 1

1.  Discuss the term Provision for Doubtful debt. 
2. Describe the entries to be made in Provision for discount account. 

3.4 Drawings

The effect of drawings by the owner of a business for personal use is to decrease the capital invested in it. Drawings may be made in cash or in the form of goods and services. Drawings made in cash required a credit entry in the bank account and debit entry in the drawings account. If drawings are made in the form of goods purchased by the business for resale, then Drawings account is debited and sales account credited with the value of goods withdrawn. The balance of the drawings account is subsequently closed at the end of the year and deducted from the capital.

SELF ASSESSMENT EXERCISE 2

1.  Discuss the concept of drawings in accounting. 
2. Describe two ways through which drawings would decrease capital. 3.5 Stock 

The usual practice in accounting is to value the goods at the lower of cost or current market price (i.e. net realizable value). This means that the closing stock of goods should not be valued above the original price paid, but if the current price is lower than original price, the current price should be taken as the valuation basis.

4.0 CONCLUSION

This Unit is an emphasis on the treatment of customers’ accounts, especially those buying goods or services on credit. As they delay payment of the value given to them on credit, relevant records have to be maintained to show the relationship between them and the business. Students have to appreciate, therefore, the various adjustments that may arise in the course of preparation of final accounts for any form of business that deals with debtors. The Unit compliments Unit 1, 3 and 4 on the issue of adjustments to final accounts.

5.0 SUMMARY

In this Unit, we have explained the accounting treatments of bad debts, provisions for bad and doubtful debts, and provision for discount on debtors, drawings and stock. We have also demonstrated how these issues are incorporated in the final accounts.