What is the bad debts reserve?and its treatment (inside or outside the trial balance)?

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 Let me explain this with the help of an example.  At the end of 2013 there are Sundry Debtors amount to Rs.50000 appear in the Trial Balance.  Some of the debtors outstanding at the end of the current year may become bad debts next year.  As sales to these debtors are made in this current year, loss on account of bad debts should be matched against the revenues of this year only.  Due to this, a part of current year’s profits are kept aside as a provision so that next year’s bad debts are written off to this provision.  It is felt that we must create a Provision for Bad Debts equal to 5% of debtors.  Entry for creating provision will be:

 

Profit & Loss A/c                Dr.   2500

  To Provision for Bad & Doubtful Debts   2500

(50000 X5/100= Rs.2500)

 

            In the Trial Balance of 2014 this provision will appear on the credit side of Trial Balance.

   Dr.                                                  Trial Balance, 2014                                             Cr.

Sundry Debtors                             60500

Provision for Bad Debts          2500

Bad Debts                                         1800

 

Adjustments: 

1. There are further bad debts of Rs.500

2. Create a provision of 5% on debtors.

 

            Bad debts which appear in the Trial Balance have already been recorded in books, that is why they are in Trial Balance.  Bad debts amounting to Rs500 which are given in Adjustments, for of all we need to record them.  The journal entry for that will be:

 

Bad Debts A/c    Dr.  500

  To Sundry Debtors           500

            Due to this journal entry the Trial will change as shown below:

                                                          Trial Balance , 2015

Sundry Debtors                             60000

Provision for Bad Debts          2500

Bad Debts                                         2300

 

           

            Now we have to create a provision of 5% on Sundry Debtors (Rs.60000 X 5/100 = Rs.3000).  What amount we shall take from this year’s P & L A/c?  Calculation for this will be:

Provision required for 2015                                                                           = Rs.3000

Less Balance already left in the provision of 2014 (Rs.2500n- Rs.2300)= Rs.  200

Balance amount to be taken from P & L A/c of 2014                                = Rs.2800

Entry for this will be same as before:

            Profit & Loss A/c                Dr.   2800

                 To Provision for Bad & Doubtful Debts   2800

 

 

answered Nov 28, 2015 by jbsclasses (3,805 points)

                                                                    Trial Balance, 2016

Sundry Debtors                             75000

Provision for Bad Debts          3000

Bad Debts                                         1500

 

Adjustments: Create a Provision for Bad Debts at 5% of Sundry Debtors.

 

            It will go on like this year after year.  But sometimes it may also happen that after writing of current year’s bad debts, amount left in the provision exceeds the provision required for the next year.  In such a case the excess provision is written back to the Profit & Loss A/c of the current year.  See the example below:

 

                                                                      Trial Balance, 2014

Sundry Debtors                             70000

Provision for Bad Debts          4000

Bad Debts                                           300

 

Adjustments: Create a provision of 5% on debtors.

 

Opening Balance in the Provision                                                                 = Rs.4000

Less Bad Debts of 2014                                                                                   = Rs.  300

Balance amount left in the Provision                                                           = Rs.3700

Provision required for 2015 (70000 X 5/100)                                             = Rs.3500

Excess amount in the Provision to be credited to P & L A/c                    = Rs.  200

Entry for this will be same as before:

 

           Provision for Bad & Doubtful Debts A/c    Dr.   200

               To Profit & Loss A/c                                                      200

 

 

 

 

 

how we will treat this 200 in the next year?? can you explain the scenario??
Your question indicates that you have not understood the working above.  Let me explain the above workings.  Trial Balance of 2014 shows Provision for Bad Debts at Rs.4000.  This provision was made in 2013 so that bad debts of 2014 are written off to this Provision.  By chance the Bad Debts in 2014 are only Rs.300.  This means after writting off bad debts of Rs.300, Rs.3700 will be still left in the Provision for Bad Debt A/c.  For 2015 you are required to have a provision @ 5% on Rs.70000.   This comes to Rs.3500 (70000 x 5%).  See there is already a balance of Rs.3700 in the Provision for Bad Debts A/c and you require only Rs.3500 for 2015, hence there is an excess provision of Rs.200 (Rs.3700 - Rs.3500).  This excess provision is no more required, hence treated as an income and credited to Profit & Loss A/c of 2014 (last journal entry).  After this entry this Rs.200 will not appear in the Balance Sheet anywhere, so we will not have to deal with this Rs.200 in the next year.

I hope I have made the point clear.  In case of any doubt, please don't hesitate to discuss further.
Thanks for your quick reply. Actually I understood your calculation at first. I was confused in the above mentioned scenario as i thought that we need to conside the exceeded amount ( 200) for the next year adjustment.but now am clear that nothing to do more and when we prepare P/L account next year we would deal only with 3500 as existing provision .
Am I right??
You are absolutely right.
Thank you so much for your clarification. Your explanation is simply superb and easly understandable. One again thank you..
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