Accountancy · Ch 1 — Depreciation, Provisions and Reserves
Provisions
Provisions
Provisions
A provision is an amount set aside out of the current period's profit to cover a known expense or loss whose exact amount is uncertain. The key idea is that the expense or loss relates to the current accounting period, but it has not yet been incurred — so its precise value cannot be known with certainty.
Why is this necessary? To ascertain the true net profit of the period. If we ignore expected losses, the profit figure would be overstated. The principle of Prudence (or Conservatism) requires that all anticipated losses be accounted for, even if their exact amount is uncertain.
Common Examples of Provisions
- Provision for Depreciation
- Provision for Bad and Doubtful Debts
- Provision for Taxation
- Provision for Discount on Debtors
- Provision for Repairs and Renewals
The Accounting Treatment
The amount of a provision is a charge against the revenue of the current period. This means it is treated as an expense, not an appropriation of profit. Creating a provision ensures proper matching of revenue and expenses, which is essential for calculating true profits.
Journal Entry:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Profit and Loss A/c | Dr. | xxx | ||
| To Provision for [Expense/Loss] A/c | xxx | |||
| (Being provision created for expected loss) |
The Profit and Loss account is debited because the provision is an expense of the current period. The provision account is credited — it is a liability (or a contra-asset) that will be used when the actual expense/loss occurs.
Presentation in the Balance Sheet
The amount of a provision can be shown in one of two ways, depending on its nature:
-
As a deduction from the related asset on the assets side. For example:
- Provision for Doubtful Debts is shown as a deduction from Sundry Debtors.
- Provision for Depreciation is shown as a deduction from the concerned Fixed Asset.
-
On the liabilities side along with current liabilities. For example:
- Provision for Taxes
- Provision for Repairs and Renewals
The distinction matters: provisions that directly reduce the value of an asset (like depreciation and doubtful debts) are deducted from that asset. Provisions that represent an expected future outflow of cash (like taxes and repairs) appear as liabilities.
Illustration: Provision for Doubtful Debts
A trader sells goods on credit. Experience shows that some debtors will default — they will either not pay at all or pay only partially. To account for this expected loss, the trader creates a Provision for Doubtful Debts.
Balance Sheet Extract (Assets Side):
| Particulars | Amount (₹) |
|-------------|-----------| …