While a business venture is being operated, it is imperative that a provision be made for dealing with certain monetary amounts that will not be paid back during the financial year. Not just that, it may so happen that those debts may never at all be paid back and therefore can be taken as complete loss for the company.
As per tradition, every business venture has provision for bad debts, which is an approximate amount that is likely to be proved as a bad loan. Since, it is not the actual amount of loss, hence chances are that there might be certain discrepancy in the whole aspect.
In case the actual amount of debt is less than amount that has been mentioned in this provision, it will remain as a credit balance in this provision for a bad debt. Since, this amount would appear in Trial Balance; hence it would be shown in a single place only, such as Credit side of the Profit and Loss account or may be deducted from total amount of (Bad debt + New provision on Debit side + further bad debts).
However, it can be shown on Liabilities side as well, where only one of the 3 treatments would be acceptable.
How to calculate this provision of Bad and Doubtful debts:
This amount is calculated on sundry debtors at a certain rate. In certain cases, there are a set of further bad debts in regards to adjustments where the provision is also to be calculated at certain rate. Here, this provision for bad and doubtful debts will be calculated in accordance with debtors after negating amount of further bad debts or bad debts on the whole.
Example 1: Let us take a Bad debt provision at 7%. If there is a further bad debt of $350, then reserve for bad debts is created at 7%.
So balance of Sundry Debtors in regards to Trial Balance is $50,000.
That is not the end. Further calculations include:
50,000 x7/100 = $ 3,500 which is the provision for bad and doubtful debts.
If $350 is taken as bad debts so amount that is due from debtors would reduce by $350, resulting in 50,000- 350 = $ 49,650.
So provision would be made on $ 49,650 only.
So final provision for bad and doubtful debts result in 49,650×7/ 100= $ 3,475.50.
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