At the end of the trading period, there are typically outstanding debtors or accounts receivable. To motivate debtors to pay their debts, companies may sometimes offer a cash discount.
For this purpose, it is necessary for the company to create a provision or allowance for the discount on debtors or accounts receivable.
In other words, it is an anticipated loss that a trader willingly bears by allowing a cash discount to those customers who settle their accounts within the prescribed time.
To make this provision, at the end of the financial year, a percentage is calculated on the total amount of sundry debtors (after deducting the provision for bad debts). The adjusting entry shown later in this article is passed to make the provision for discount on debtors.
In December 2019, the total sundry debtors of a business are $30,000. The company decides to create a Provision for Bad Debts @ 5% and a Provision for Discount on Debtors @ 3% p.a. on sundry debtors.
- Provision for bad debts = 30,000 x5/100 = $1,500
- Remaining good debtors = 30,000 – 1,500 = $28,500
- Provision for discount on debtors = 28,500 x 3/100 = $855
The amount of the provision for discount on debtors is an anticipated loss of the business, while on the other hand, it is a reduction in the value of the debtors account. Provision for discount on debtors has the following two effects on the final accounts:
- It is a loss of the business, meaning that it will be recorded on the debit side of the profit and loss account.
- On the other hand, it is a decrease in the value of assets (i.e., debtors), meaning that it will be deducted from the debtors account on the asset side of the balance sheet.
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