Provisions, Reserves, and Bad Debts (Including Provision for Doubtful Debts) Questions

Question 1

Define bad debts.

Accepted Answer

Bad debts are amounts due from debtors that have become definitely irrecoverable.

Question 2

What is provision?

Accepted Answer

Provision is a charge against profit made to meet a known liability or a probable loss.

Question 3

Define reserve.

Accepted Answer

Reserve is an appropriation of profit created after profit is ascertained to strengthen financial position or meet future requirements.

Question 4

What is meant by doubtful debts?

Accepted Answer

Doubtful debts are debts whose recovery is uncertain and may become bad in future.

Question 5

Where is provision for doubtful debts shown in balance sheet?

Accepted Answer

Provision for doubtful debts is shown as a deduction from sundry debtors to arrive at net realisable value.

Question 6

Bad debts recovered are treated as what?

Accepted Answer

Bad debts recovered are treated as income and credited to Profit & Loss account in the year of recovery.

Question 7

Explain accounting treatment of bad debts.

Accepted Answer

When a debt becomes definitely irrecoverable, it is written off by debiting Bad Debts A/c and crediting the debtor’s account (Bad Debts A/c Dr. To Debtors A/c). This reduces the amount receivable. Bad debts are then charged to Profit & Loss account as an expense, reducing net profit. In the balance sheet, debtors are shown after deducting the bad debts written off, so current assets are not overstated.

Question 8

Explain the need for provision for doubtful debts.

Accepted Answer

Provision for doubtful debts is created to cover expected losses from debtors whose recovery is uncertain. It follows the prudence concept by recognising probable losses in the current period, so profit is not overstated. It also ensures that debtors are shown at net realisable value in the balance sheet. Without provision, both profit and debtors may be reported higher than what is realistically recoverable.

Question 9

Differentiate between provision and reserve.

Accepted Answer

Provision is a charge against profit created to meet a known liability or probable loss and is made before arriving at net profit; it reduces current profit (e.g., provision for doubtful debts). Reserve is an appropriation of profit made after net profit is ascertained to strengthen financial position or meet future needs; it does not affect net profit calculation (e.g., general reserve). Thus, provisions relate to expected losses/obligations, while reserves represent retained profits.

Question 10

Explain how provision for doubtful debts is shown in balance sheet.

Accepted Answer

Debtors are shown at their net realisable value. Therefore, from gross sundry debtors, further bad debts (if any) are deducted first, and then provision for doubtful debts is deducted. The presentation is: Debtors (Less: bad debts, Less: provision for doubtful debts) = Net debtors. This prevents overstatement of current assets and presents the likely amount to be realised from debtors.

Question 11

Write a short note on capital reserve and revenue reserve.

Accepted Answer

Capital reserve is created out of capital profits such as profit on sale of fixed assets or revaluation surplus; it is generally not available for dividend distribution. Revenue reserve is created out of operating profits earned in the normal course of business and can be used for dividends, expansion and contingencies. The main difference is the source of profit and the permitted utilisation.

Question 12

Explain treatment of bad debts recovered.

Accepted Answer

Bad debts recovered are amounts received later which were previously written off as bad. They are treated as income in the year of recovery because the expense was already charged in an earlier year. Usually, Cash/Bank A/c is debited and Bad Debts Recovered A/c is credited, and then it is transferred to Profit & Loss account. This increases profit in the year of recovery.

Question 13

Explain bad debts and provision for doubtful debts with accounting treatment.

Accepted Answer

Bad debts are actual losses arising when a debtor fails to pay and the amount becomes definitely irrecoverable. They are written off by passing the entry: Bad Debts A/c Dr. To Debtors A/c. Bad debts are charged to Profit & Loss account as an expense, reducing net profit, and debtors reduce in balance sheet.

Provision for doubtful debts is an estimate of probable future losses from debtors whose recovery is uncertain. It is created as a charge against profit following the prudence concept to prevent overstatement of profit and debtors. If provision is created/increased, entry is: Profit & Loss A/c Dr. To Provision for Doubtful Debts A/c. If provision is reduced, excess is credited back: Provision for Doubtful Debts A/c Dr. To Profit & Loss A/c.

In the balance sheet, debtors are shown at realisable value: Sundry Debtors (Less: bad debts written off / further bad debts, Less: provision for doubtful debts) = Net debtors. This treatment ensures true profit and true financial position.

Question 14

Differentiate between provisions and reserves. Explain with examples.

Accepted Answer

Provision is created to meet a known liability or a probable loss and is treated as a charge against profit. Therefore, it is made before arriving at net profit and reduces the profit of the period. Examples include provision for doubtful debts and provision for depreciation.

Reserve is an appropriation of profit created after net profit is ascertained. It is meant to strengthen the financial position or meet future needs/contingencies. Examples include general reserve and dividend equalisation reserve.

Capital reserve arises from capital profits (profit on sale of fixed assets, revaluation surplus) and is generally not used for dividend, whereas revenue reserves arise from operating profits and may be used for dividend. Thus, provisions relate to expected losses/obligations and affect profit calculation, while reserves represent retained profits and affect distribution and financial strength.

Question 15

Explain provision for doubtful debts and show the working and balance sheet presentation (format).

Accepted Answer

Provision for doubtful debts is created to cover expected losses from debtors and to show debtors at net realisable value.

**Working (format):**
1. Sundry Debtors (as per trial balance)
2. Less: Further bad debts (if any)
3. Net debtors
4. Required provision = Net debtors × given %
5. Compare required provision with existing provision to find increase/decrease (increase is debited to P&L; decrease is credited to P&L).

**Balance sheet presentation (format):**
Sundry Debtors
Less: Bad debts (written off / further bad debts)
Less: Provision for doubtful debts
= Net Debtors (current asset).

This method ensures profit is not overstated and debtors are shown at a realistic amount likely to be realised.

Provisions, Reserves, and Bad Debts (Including Provision for Doubtful Debts)

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