Why is it necessary to create a provision for doubtful debts at the time of preparation of final accounts?
It is necessary to create a provision for doubtful debts at the time of preparation of final accounts because it is a normal feature of business operations that some debts prove irrecoverable. Since it is not possible to accurately know the exact amount of such bad debts, a reasonable estimate of such loss is made and provided for.
This helps in bringing a certain element of certainty in the amount of bad debts charged every year against incomes. The provision is created by debiting Profit and Loss Account, which reduces the current year's profit on account of doubtful debts.
In the Balance Sheet, the provision for doubtful debts is shown as a deduction from the debtors on the asset side. This helps portray correctly the expected realisable value of debtors and ensures a true and fair view of the financial position.
Explanation
The textbook context explains that: (1) Some debts become irrecoverable as a normal business feature, (2) Accurate prediction of bad debts is impossible, hence reasonable estimates are made, (3) This brings certainty to bad debts charged against income each year, (4) The provision is created by debiting P&L A/c and is deducted from debtors in the Balance Sheet to show correct realisable value.