Journal entry for provision are liabilities that a business recognizes for future obligations or losses. They are set aside to cover uncertain future expenses and are a crucial part of accurate financial reporting. Common types of provisions include those for doubtful debts, warranties, and legal claims.
Key Concepts
- Provision: A liability of uncertain timing or amount.
- Expense: The cost recognized in the income statement when a provision is created.
- Liability: The obligation recorded on the balance sheet when a provision is created.
Journal Entry for Provisions
When a provision is recognized, the following journal entry is made:
Example Scenario: Provision for Doubtful Debts
Assume a business estimates that ₹10,000 of its accounts receivable may not be collected and decides to create a provision for doubtful debts on 31-12-2023.
Step-by-Step Journal Entry
- Record the Provision for Doubtful Debts
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Bad Debt Expense | 10,000 | Provision for doubtful debts | |
| 31-12-2023 | To Provision for Doubtful Debts | 10,000 | Recognize provision for doubtful debts |
Explanation
- Debit to Bad Debt Expense: This increases the expense account, reflecting the estimated cost of uncollectible accounts.
- Credit to Provision for Doubtful Debts: This increases the liability account, reflecting the obligation recognized for potential bad debts.
Alternative Scenarios
Provision for Warranties
If a business offers warranties on its products and estimates future warranty costs, it creates a provision for warranties.
Example: A business estimates ₹50,000 for future warranty costs on 31-12-2023.
Journal Entry to Record Provision for Warranties:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Warranty Expense | 50,000 | Provision for future warranty costs | |
| 31-12-2023 | To Provision for Warranties | 50,000 | Recognize provision for warranties |
Provision for Legal Claims
If a business anticipates future legal claims and estimates the associated costs, it creates a provision for legal claims.
Example: A business estimates ₹30,000 for future legal claims on 31-12-2023.
Journal Entry to Record Provision for Legal Claims:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Legal Expense | 30,000 | Provision for future legal claims | |
| 31-12-2023 | To Provision for Legal Claims | 30,000 | Recognize provision for legal claims |
Conclusion
Creating provisions ensures that a business accurately reflects potential future obligations in its financial statements. Provisions help in managing uncertainties and provide a more realistic picture of the financial position.