In ledger accounting, recording doubtful debts is crucial for anticipating potential losses from customers who may not fulfill their payment obligations. A provision for doubtful debts reflects an estimate of the portion of accounts receivable that might become uncollectible. This example demonstrates how to create, adjust, and utilize provisions for doubtful debts with detailed ledger entries and explanations.
1. Scenario Overview
XYZ Company has the following accounts receivable as of December 31:
- John Smith: $5,000
- Mary Johnson: $3,000
- David Brown: $2,000
Based on past experience, XYZ Company estimates that 10% of its total accounts receivable may become uncollectible. Additionally, by the end of the next period, the company determines that John Smith’s $5,000 debt is definitely uncollectible, requiring a write-off.
2. Calculating the Provision for Doubtful Debts
Total Accounts Receivable = $5,000 + $3,000 + $2,000 = $10,000
Provision for Doubtful Debts = 10% of $10,000 = $1,000
3. Journal Entries for Doubtful Debts
A. Creating the Provision for Doubtful Debts
Journal Entry (December 31):
Debit: Doubtful Debts Expense $1,000
Credit: Provision for Doubtful Debts $1,000
Doubtful Debts Expense Ledger
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision for Doubtful Debts Created | $1,000 | $1,000 Dr. |
Provision for Doubtful Debts Ledger
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision Created | $1,000 | $1,000 Cr. |
4. Writing Off a Bad Debt Against the Provision
By March of the following year, XYZ Company determines that John Smith’s $5,000 debt is definitely uncollectible and decides to write it off against the existing provision.
B. Journal Entry for Writing Off the Bad Debt (March 31):
Debit: Provision for Doubtful Debts $1,000
Debit: Bad Debts Expense $4,000
Credit: Accounts Receivable – John Smith $5,000
Provision for Doubtful Debts Ledger (After Write-off)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision Created | $1,000 | $1,000 Cr. | |
| Mar 31 | Bad Debt Written Off (John Smith) | $1,000 | $0 |
Bad Debts Expense Ledger (Including Additional Write-off)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 | Provision for Doubtful Debts Created | $1,000 | $1,000 Dr. | |
| Mar 31 | Additional Bad Debt Expense (John Smith) | $4,000 | $5,000 Dr. |
Accounts Receivable Ledger (John Smith)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Jan 5 | Sale on Credit | $5,000 | $5,000 Dr. | |
| Mar 31 | Bad Debt Written Off | $5,000 | $0 |
5. Adjusting the Provision for Doubtful Debts
At the end of the year, XYZ Company reassesses its accounts receivable, which now total $5,000 (after writing off John Smith’s debt). The company decides to maintain the 10% provision, requiring a new provision of $500.
C. Journal Entry for Adjusting the Provision (December 31):
Debit: Doubtful Debts Expense $500
Credit: Provision for Doubtful Debts $500
Provision for Doubtful Debts Ledger (After Adjustment)
| Date | Description | Debit (Dr.) | Credit (Cr.) | Balance |
|---|---|---|---|---|
| Dec 31 (Previous Year) | Provision Created | $1,000 | $1,000 Cr. | |
| Mar 31 | Bad Debt Written Off (John Smith) | $1,000 | $0 | |
| Dec 31 (Current Year) | Provision Adjustment | $500 | $500 Cr. |
6. Impact on Financial Statements
A. Income Statement (End of Year)
| Particulars | Amount |
|---|---|
| Sales Revenue | $20,000 |
| Less: Bad Debts Expense (John Smith) | ($4,000) |
| Less: Doubtful Debts Expense (Provision) | ($1,500) |
| Net Income | $14,500 |
B. Balance Sheet (End of Year)
| Assets | Amount |
|---|---|
| Accounts Receivable | $5,000 |
| Less: Provision for Doubtful Debts | ($500) |
| Net Accounts Receivable | $4,500 |
7. Managing Doubtful Debts in Ledger Accounting
This example demonstrates how to create, adjust, and apply provisions for doubtful debts in ledger accounting. By regularly reviewing accounts receivable and making appropriate provisions, businesses can ensure accurate financial reporting and better manage credit risk. The provision for doubtful debts helps maintain the integrity of financial statements and supports informed decision-making.