The provision in accounting means that amount which is charged against Profit or loss account(Income statement) for some uncertain amount of known liability which will be incurred in the near future.
To calculate the true profit or loss of the business for the current year, we have to charge the unknown amount of known expenses or liabilities which are related to current year operating activities to profit/loss account on the proportionate basis by making provision for this amount at the time of preparing financial statements.
For example, We have always some sort of debtors which will not pay our dues, So provision for doubtful debts is created to charge that amount of loss to Profit/loss account (income statement).
“According To Part III, Schedule VI of the Companies Act, 1956,
The expression ‘provision’ shall mean (i) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or (ii) retained by way of providing for known liability or which the amount cannot be determined with substantial accuracy. ”
Types and treatment of Provision in accounting:-
Thus the creation of provision ensures proper matching of revenues and expenses and calculation of true profit. The following provisions are created at the time of preparing financial statement:-
Generally, there are some of the debts which cannot be realized from the debtors/receivable due to various reasons like death of debtors, insolvency, liquidation or debtors are not traceable etc. These type of debtors/receivable are treated in the books as a term of bad debts. The Accounting journal entry of provision for bad Debts is shown in the image below.
To get payment earlier we have to give the discount to our sundry debtors/ Receivables. So, we have made provision for a discount to debtors/receivable in the current year. The Accounting journal entry of provision for Discount to debtors is shown in the image below.
The creditors/payable will also give us the discount to get paid earlier. So, we have made provision for the discount from Creditors/Payable in the current year.
However, in practicality if, there is an agreement between the business and the creditors for some provision of discount/cashback (as in case of digital transactions nowadays), only then, shall one provide for the discount from creditors. The discount provision is available in advance as a rate or as mentioned in the agreement.
The Accounting journal entry of provision for Discount from Creditors is shown in the image below.
The Provision for taxation is created to meet expected income tax payable on the income of the current year. The Accounting journal entry of provision for Taxation is shown in the image below.
When the original book value of assets shown in the Balance sheet and Accumulated depreciation/Provision for depreciation account opened and shown it in the liability side of the balance sheet or can be subtracted from the asset account. The Accounting journal entry of provision for Depreciation is shown in the image below.
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