Lesson Notes By Weeks and Term - Senior Secondary School 2

SUBJECT: FINANCIAL ACCOUNTING

CLASS:  SS 2

DATE:

TERM: 1st TERM

TOPIC: FINAL ACCOUNTS PROVISION FOR DOUBTFUL DEBTS

PROVISION FOR DOUBTFUL DEBTS

Although a debt may not actually have become bad, there may be doubt as to whether it will be paid.  It would be misleading to include that debt as an asset in the balance sheet pretending that the amount is not in doubt.  On the other hand, since it has not yet become bad, it would be wrong to write it off.  A provision is therefore made to cover such doubtful debt.

Provision for doubtful debt is a mere estimate of the total debt that may not be collected from the debtor.  This estimated expense for bad debts which cannot be calculated with substantial accuracy is charged to the profit and loss account as an expense.

HOW TO CREATE AND MAINTAIN A PROVISION FOR DOUBTFUL DEBTS

1. When the provision for doubtful debt is first created;

    Debit         Profit and Loss Account

    Credit         Profit for doubtful debts Account

with the full amount of the provision

In the years that follow, the entries in the accounts will be for increases or decreases in the amounts required for the provision.

1. INCREASING THE PROSIVION FOR DOUBTFUL DEBTS 

    Debit        Profit and Loss Account

    Credit         Profit for doubtful debts Account

with increases in the provision.

1. DECREASING THE PROVISION FOR DOUBTFUL DEBTS

    Debit         Profit for doubtful debts Account

    Credit         Profit and Loss Account

with decreases in the provision.

In all the instances (A-C) as described above, the provision for Doubtful Debts is deducted 

from the Debtors in the Balance Sheet.

EVALUATION

1. Explain the following terms:

    (a) Bad debts      (b) Provision for doubtful debts

2. List three types of provisions that could give rise to adjustments in the final accounts.

Illustration

A business starts on 1 January, 2002 and its financial year end is 31 December annually.  A table of the debtors, the bad debts written off and the estimated doubtful debts at the end of each year is now given.

Year to             Debtors at        Bad debts        Debts thought

31 December            end of year        written off        at end of year

                (after bad debts    during the year    to be doubtful to 

                written off)                    collect

                N            N            N

2002                6,000            423            120

2003                7,000            510            140

2004                8,000            604            155

2005                6,400            610            130

You are required to show for each of the year ended 31st December……

(a)    Bad Debts Account

(b)    Provision for Doubtful Debts Account

(c)    Profit and Loss Account (extracts)

(d)    Balance Sheet (extracts)

Bad Debts

2002                N    2002                N

Dec. 31 Sundries        423    Dec. 31 Profit and Loss    423

2003                    2003

Dec. 31  Sundries        510    Dec. 31 Profit and Loss    510

2004                    2004

Dec. 31 Sundries        604    Dec. 31 Profit and Loss    604

2005                    2005

Dec. 31 Sundries        610    Dec. 31 Profit and Loss    610

Provision for Doubtful Debts

2002                N    2002                N

Dec. 31 Balance c/d        120    Dec. 31 Profit and Loss    120

2003                    2003

Dec. 31 Balance c/d        140    Jan 1 Balance b/d        120

                    Dec 31 Profit and Loss      20

1. 140

2004                    2004

Dec. 31  Balance c/d        155    Jan 1   Balance b/d        140

                    Dec. 31 Profit and Loss      15

1. 155

2005                    2005

Dec. 31 Profit and Loss      25    Jan. 1 Balance b/d        155

“       “   Balance c/d        130                   

                155                    155

Profit and Loss Account (extracts) for the year ended 31st December

                N                    N

2002    Bad Debts        423

Provision for         120

Doubtful debts       

2003    Bad Debts        510

    Increase in 

Provision for 

Doubtful debts          20

2004    Bad Debts        604

    Increase in provision

    For Doubtful debts      15

2005    Bad Debts        610        2005    Reduction in provision 

for Doubtful Debts        25 

Balance Sheet (extracts) as at 31st December

                                    N        N

                2002        Debtors        6,000

                        Less: Provision

                        For Doubtful Debts        120        5,880

                2003        Debtors        7,000

                        Less: Provision for

                        Doubtful Debts      140        6,860

                2004        Debtors        8,000

                        Less: Provision for

                        Doubtful Debts    155        7,845

                2005        Debtors        6,400

                        Less: Provision for

                        Doubtful Debts      130        6,270

EVALUATION

1. Differentiate between provision for bad debts and provision for depreciation.
2. List two characteristics of provisions in financial accounting.

GENERAL EVALUATION

1. State five differences between cash discount and trade discount
2. Identify any seven prime books of account and highlight the uses of each of them where necessary
3. List five advantages of using the imprest system to record petty cash transactions
4. Explain the following types of errors (a) omission (b) principle (c) commission (d) original entry (e) complete reversal of entry (f) compensating error
5. Explain how the following items are treated in Profit and Loss Account and Balance

      Sheet (a) provision for doubtful debts (b) bad debts recovered

READING ASSIGNMENT

Simplified and Amplified Financial Accounting Page 143-150

WEEKEND ASSIGNMENT

1. A decrease in the provision for doubtful debts results in _______

(a) an increase in net profit      (b) a decrease in gross profit     (c) an increase in gross profit     (d) a decrease in net profit

2. The term bad debts means debt ________

(a) recorded in a wrong account    (b) owed by an employee     (c) paid with fake currency     (d) that cannot be collected again from the debtor

3. The gross profit for a trading period is calculated as _________

(a) Net sales less net purchases    (b) Net sales less cost of sales    (c) Net sales less closing stock    (d) Net sales plus cost of goods sold

Use the information below to answer questions 4 and 5

                            N

    Provision for bad debts            1,000 Cr

    Bad Debts                      500 Dr

    Debtors                          50,000 Dr

Additional bad debts to be written off    500

New provision for bad debts to stand at 5% of debtors.

4. In the balance sheet the net figure for debtors is ________

    (a) N47,025        (b) N46,550       (c) N45,600        (d)  N43,225

5. The total amount of bad debts to be charged as expenses in the profit and Loss Account is _________

    (a) N2,000      (b) N1,500        (c) N1,000        (d)  N500

THEORY

Mr. Okonkwo’sbooks of account shows the information for four years ended 31st December, 2000.  The balance of debtors and bad debts were given for the four years.

                        Debtors            Bad

                        Balance            Debts

                        N                N

    31st December, 1997            40,000                2,000

    31st December, 1998            30,000                1,000

    31st December, 1999            50,000                2,500

    31st December, 2000            60,000                3,000

Provision for doubtful debts brought forward at 1st January, 1997 was N600.

Mr. Okonkwo makes provision for doubtful debts at the rate of 10% on total debtors outstanding after deducting bad debts for the period.

You are required to prepare the following accounts for the years ended 31st December, 1997, 1998, 1999 and 2000.

(a)    Bad Debts Account

(b)    Provision for doubtful debts Account

(c)    Profit and Loss Account

(d)    Balance Sheet (extract)