How to calculate and record the provision for doubtful debts

Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements

What you need

• The trade receivables (debtors) balance at year end.
• The amount of bad debts to be written off first (if any).
• The provision for doubtful debts rate (percentage) set by the business.
• The provision for doubtful debts balance brought forward from the previous year (if any).

Step by step

1. 1

   Calculate net trade receivables

   Take the trade receivables balance at year end and first deduct any bad debts written off. For Perniagaan Setia on 31 December 2023, the trade receivables balance is RM52,000 and bad debts of RM2,000 are written off with the entry Debit Bad Debts RM2,000; Credit Trade Receivables RM2,000. The net balance used as the basis is RM52,000 - RM2,000 = RM50,000.

2. 2

   Calculate the provision required

   Multiply the net trade receivables by the set provision rate. Perniagaan Setia sets 5%. Provision required = 5% x RM50,000 = RM2,500. This is the closing balance the Provision for Doubtful Debts account must hold on 31 December 2023.

3. 3

   Check the existing provision balance

   Look at the provision for doubtful debts balance brought forward from last year. Because 2023 is the first year the provision is created, the existing balance is RM0. So the whole RM2,500 is the provision created for the first time.

4. 4

   Determine an increase or a decrease

   Compare the provision required with the existing balance. Difference = RM2,500 - RM0 = RM2,500 (increase). Remember, after the first year only this difference is recorded in the double entry, not the whole provision every year.

5. 5

   Record when the provision increases

   When the provision required exceeds the existing balance, record the increase as an expense. First year: Debit Profit and Loss RM2,500; Credit Provision for Doubtful Debts RM2,500. By 31 December 2024, Perniagaan Setia's net trade receivables rise to RM60,000, so provision required is 5% x RM60,000 = RM3,000. The existing balance is RM2,500, so add only RM500: Debit Profit and Loss RM500; Credit Provision for Doubtful Debts RM500. The provision balance is now RM3,000.

6. 6

   Record when the provision decreases

   When the provision required is less than the existing balance, reverse the direction of the entry. On 31 December 2025 Perniagaan Setia's net trade receivables fall to RM40,000, so provision required is 5% x RM40,000 = RM2,000. The existing balance is RM3,000, so it decreases by RM1,000: Debit Provision for Doubtful Debts RM1,000; Credit Profit and Loss RM1,000. The provision balance is now RM2,000.

7. 7

   Report in the Income Statement

   An increase in the provision is recorded as an expense. Example 2024: 'Provision for Doubtful Debts RM500' is deducted in the expenses section. A decrease in the provision is recorded as income (other income). Example 2025: 'Decrease in Provision for Doubtful Debts RM1,000' is added in the income section. The bad debts of RM2,000 (2023) are recorded separately as a full expense, not mixed with the provision.

8. 8

   Report in the Statement of Financial Position and carry the balance forward

   Under current assets, show trade receivables less the provision for doubtful debts balance. On 31 December 2024: Trade Receivables RM60,000 - Provision for Doubtful Debts RM3,000 = RM57,000 realisable value. The provision balance of RM3,000 is carried forward as the opening balance for 2025, and the process repeats at the end of the following year.

Second example

Kedai Harmoni sets a provision for doubtful debts of 3%. On 31 December 2023, net trade receivables are RM80,000, so the first provision is 3% x RM80,000 = RM2,400: Debit Profit and Loss RM2,400; Credit Provision for Doubtful Debts RM2,400. On 31 December 2024, net trade receivables fall to RM70,000 as many customers settled their debts, so the provision required is 3% x RM70,000 = RM2,100. Because the existing balance of RM2,400 is higher, the provision decreases by RM300: Debit Provision for Doubtful Debts RM300; Credit Profit and Loss RM300. In the 2024 Income Statement, RM300 is recorded as income, and in the Statement of Financial Position, trade receivables RM70,000 less provision RM2,100 gives a realisable value of RM67,900.

Suppose on 31 December 2025 Kedai Harmoni has trade receivables of RM75,000, but RM3,000 of it is written off as bad debts first, so the basis for calculation is RM75,000 - RM3,000 = RM72,000. The provision required is 3% x RM72,000 = RM2,160; because the existing balance is RM2,100, the provision increases by only RM60: Debit Profit and Loss RM60; Credit Provision for Doubtful Debts RM60. This shows that bad debts must be deducted before the provision rate is applied.

Common mistakes

Related chapter: Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements →

All procedures →