Provision for Discount on Debtors

Provision for Discount on Debtors

A business often offers discounts to its debtors to encourage them to pay early. This discount is an expense for the business, and the amount likely to be allowed in the current accounting year can be estimated in advance. Creating a provision for discount on debtors allows the business to account for this probable expense in the same year the sales are made, following the matching principle.

Key Rule: Provision is Only on Good Debtors

The provision for discount is not calculated on the total debtors. It is calculated only on good debtors — that is, debtors from whom the business expects to receive payment. To find the value of good debtors, you must first deduct:

1. Further Bad Debts (any debts now confirmed as irrecoverable)
2. Provision for Doubtful Debts (the estimated amount that may become bad)

The remaining amount represents the debtors who are expected to pay, and it is on this amount that the provision for discount is calculated.

Accounting Treatment

The journal entry to create this provision is:

This entry reduces the current year's profit by the estimated discount amount. In the Balance Sheet, the provision is shown as a deduction from the debtors figure, giving the expected realisable value of debtors.

Worked Example from the Textbook

Ankit's debtors before adjustments are ₹15,500. The following adjustments are made:

• Further Bad Debts: ₹2,500 (these are written off, reducing debtors to ₹13,000)
• Provision for Doubtful Debts: ₹650 (created on the remaining ₹13,000)
• Good Debtors: ₹13,000 – ₹650 = ₹12,350
• Provision for Discount on Debtors: 5% of ₹12,350 = ₹227 (the textbook uses this figure)

The adjustment entry is:

Presentation in Final Accounts

In the Profit and Loss Account (Dr. side):

In the Balance Sheet (Assets side):

Treatment in the Subsequent Year …