Question

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

Answer 1

Provisions are the amount that is created against profit to meet the known liability; however, the amount of liability is uncertain. It is created for specific liability.

Creation of provision is compulsory even if, there is no profit. The underlying principle behind creation of provision is conservatism, viz., to prepare for future loss.

The main rationale for making provisions is to provide cushion to the future business performance against the uncertain and unforeseen losses that may arise from the past transactions.

A few examples of provisions are given below:

1. Provision for bad and doubtful debts

2. Provision for depreciation

3. Provision for taxation

4. Provision for discount on debtors

Provisions are made by debiting the Profit and Loss Account on estimated basis.

The provisions are created on the basis of past experiences. Every year, a business may experience common losses, such as depreciation of fixed assets, taxation, etc., which are although known; however, their exact amount of future period is unknown.

Thus, business creates provision of certain percentage every year, which is truly based on the intuitions and past experiences.

These unascertained liabilities in form of provisions are kept aside, which help future business activities, undisturbed from the future losses.

Accounting treatment for provision for doubtful debts is:

Profit and Loss A/c   Dr.
  To Provision for Doubtful Debts
(Provision for doubtful debt made)