Page 246 - DMGT104_FINANCIAL_ACCOUNTING

Financial Accounting

Notes When it is certain that a debt will not be recovered, the amount is written off as bad debts. But it
is also likely that some of the remaining debts may not be recovered in full. This will be a loss
to the business. Hence, it is a common practice to make a suitable provision for doubtful debts
at the time of ascertaining the profit or loss. The balance sheet will not show the true position of
sundry debtors. The provision for doubtful debts is usually calculated as a certain percentage of
the total amount due from sundry debtors after writing off all known bad debts. Provision for
doubtful debts is also called ‘Provision for Bad Debts’, or ‘Provision for Bad and Doubtful debts’.

Such a provision is made by debiting the amount of doubtful debts to the profit and loss account
and crediting the account of provision for doubtful debts. Thus, the journal entry for creating
such a provision is as follows:
Profit and Loss A/c Dr.
Provision for Doubtful Debts A/c
The bad debts arising during the year are first written off from the ‘provision for doubtful debts’
account. In doing so, the opening balance standing to the credit of the provision for doubtful
debts account may not be sufficient to meet the current amount of bad debts as also the
requirements of future doubtful debts. This deficit is to be provided for at the end of the year by
a charge to the profit and loss account. In case, the annual amount provided for is to be adjusted
for any unused surplus representing credit balance. The following are the journal entries required
when the provision for bad debts exists in the books:
1. For writing off further bad debts given outside the trial balance:
Bad Debts A/c Dr.
Sundry Debtors A/c

2. For transferring the total bad debts to the provision for Bad Debts Account:
Provision for Doubtful Debts A/c Dr.
Bad Debts A/c
3. For debiting the Profit and Loss Account with the amount of new provision plus the excess
of bad debts over the old provision:
Profit and Loss A/c Dr.
Provision for Doubtful Debts A/c
4. For crediting the Profit and Loss Account with excess of the old provision over the total
bad debts plus new provision, if any:
Provision for Doubtful Debts A/c Dr.
Profit and Loss A/c

10.4.6 Types of Reserves

Reserves are broadly of two types—Capital Reserve and Revenue Reserve
 Capital Reserve: ‘Capital Reserve’ is an accounting mechanism for conserving profits. The
amount so set apart as ‘Capital Reserve’ imparts an element of stability to the overall
finances of a business enterprise. Capital reserve arises either as a gain on sale of long-term
assets or an settlement of liabilities. Again of capital nature may also arise due to the basic
transaction of being of capital nature. For example, sale of equity shares at a premium.
Further, allocation of revenue reserve may be made to capital reserve due to legal
obligations. Capital reserve does not include any free balance that might be used for the

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