Question 22 of 43advanced🔧 ApplyLong Answer6 marks

What are 'provisions'. How are they created? Give accounting treatment in case of provision for doubtful Debts.

Correct Answer

Provisions are certain expenses or losses which are related to the current accounting period but the amount of which is not known with certainty because they are not yet incurred. It is necessary to make provision for such items for ascertaining true net profit. For example, a trader selling on credit creates a provision for doubtful debts to take care of expected loss. This follows the principle of Prudence or Conservatism.

Creation of provision ensures proper matching of revenue and expenses. The amount of provision is a charge against the revenue of the current period. Provisions are created by debiting the Profit and Loss Account.

In the case of Provision for Doubtful Debts, the amount is calculated as a certain percentage of the total amount due from sundry debtors after deducting all known bad debts. The journal entry recorded is: Profit and Loss Account Dr. to Provision for Doubtful Debts Account.

In the Balance Sheet, the amount of provision for doubtful debts is shown by way of deduction from the concerned asset on the assets side. It is deducted from the amount of Sundry Debtors. Other provisions, like taxes, may be shown on the liabilities side along with current liabilities.

Exercise: Long Answers | Q: 6 | (Page 45)
For More Understanding

Explanation

The answer is derived directly from Section 7.11 and 7.11.1 of the text. It defines provisions based on the uncertain nature of certain current expenses/losses. It explains the creation process via the Profit and Loss Account to match revenues. Finally, it details the specific journal entry and the Balance Sheet presentation (deduction from debtors) as explicitly described in the 'Accounting Treatment for Provisions' section.

Solution Steps

  1. Step 1: Define Provisions as expenses/losses related to the current period with uncertain amounts.

  2. Step 2: Explain creation via debiting Profit and Loss Account to match revenue and expenses.

  3. Step 3: Provide the specific journal entry: Profit and Loss A/c Dr. to Provision for doubtful debts A/c.

  4. Step 4: Describe Balance Sheet presentation as a deduction from the concerned asset (Sundry Debtors).

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