Cheque dishonour

Since there is a valid negotiable instrument for the full amount, X can certainly book the interest of Rs 33. However, X will have to make a provision for doubtful debts in the same year itself for the full amount ie Rs 10033, on the basis of prudence principle Y (Dr) 10000 Sales (Cr) 10000 Y (Dr) 33 Interest income (Cr) 33 Bank. (Dr) 10033 Y (Cr) 10033 Provision for doubtful debts. Dr 10033 Profit and loss Account. Cr. 10033

Dear Vivek

 

I am not getting your entries.

 

Why will we debit interest when we are entitled to receive it ??

 

and why provision when the party has later given us the full amount ??

 

 

In the books of X :

1-4.       Y Dr      10000

              To Sales 10000

15-4      Bank Dr. 10033

               To Y.  10000

                To Interest   33

15-4.     Interest Dr 33

              Y Dr 10000 

                To Bank 10033

20 -4.      Bank a/c Dr. 10066

                 To Y 10000

                 To Interest  66

Here you have an option to not reverse the Interest received amount on dishonour of cheque as even if not received it is accrued. Y's account will be debited with 10033 in that case in the dishonour entry and subsequent change will also have to be made in last entry by adding 33 in Y's a/c and deducting it from Interest.

 

Dear shivani, Interest is not debited but its credited. In fact, I replied to the post from my mobile phone, perhaps that was the reason why the alignment was lost. The proposed entries are given below

1. On Sales made:

Y (Dr) 10033

Sales (Cr) 10000

Interest Income (Cr) 33

2. On receipt of cheque (if received on a later date)

Bank Dr 10033

Y (Cr) 10033

3. On dishnour of cheque

Y (Dr) 10033

To bank 10033

4. For creating provision

Provision for bad/doubtful debts 10033

To Profit & Loss Account 10033

5. When payment is made on 20/4

a. Profit & Loss a/c 10033

Provision for bad/doubtful debts 10033

b. Bank (Dr) 10066

Y (Cr) 10033

Interest Income (Cr) 33

When the cheque got dishonoured, we are not sure that we could realise that amount on a later date. assuming the cheque was presented to the bank on 15/4, we dont know at that time that Y woud pay the money on 20/4. Therefore, to be prudent, we need to recognise the anticipated loss arising from failure in collection of revenue viz sales. Thats  the reason why provsion has to be created on the date on which cheque was dishonoured. However, when Y ultimately pays the amount, we should reverse the provision

Dear Vivek

 

Provision ki entry ulta pulta lag rahi hai.

debit ko credit kar diya aur credit ko debit.

time to change mobile

tell me why to create provisions in between the financial year, dont we create provisions at the end of the year ?

 

regards

Dear Shivani,

If you please translate the first sentences into English, I may be able to fully appreciate the humour in it, as I’m not well versed in Hindi..

To my knowledge, there is no stringent rule that provision has t o be made only at the year end

In my opinion it is improper to derecognize here, the interest revenue considering the definition of revenue itself as per AS-9. AS-9 defines revenue as the gross inflow of cash, receivables or other consideration arising to the enterprises………

Here a valid negotiable instrument that we got out of the sale of goods can certainly be considered as the gross inflow of other consideration. As long as such an instrument is kept by us, derecognition of revenue when the cheque got dishonored, whether it be sales or interest relating to sales, may not be logical.

Even then considering the prudence principle, we need to recognize the anticipated loss immediately when the cheque got dishonored. We cant simply write it off as bad debt since we have a valid instrument and our right to receive the cheque amount of Rs. 10033 can be legally enforceable through the court of law. In effect, we cannot say, at the time of dishonor, that we have lost that amount; but we may lose it in the future. The best way to record an anticipated loss, which may or may not happen, is the creation of a related provision.

For instance, even in a situation where a debtor becomes insolvent, the condition which provides lesser chance to collect the outstanding balance, we are neither derecognizing the corresponding sales nor we are debiting a bad debt account; rather we create a provision for the outstanding balance. The same rationale applies here too.

All what I have said above is based on the assumption that the cheque was received on 15/4 and the amount mentioned in the cheque is inclusive of interest and that’s the reason why the question of recognition of interest arises.

Dear vivek

 

suppose we sold goods of Rs. 10000 to X. X pays us 6000 and says that he wont pay rest.

then what we do ?

do we not book bad debts at that time as we know he wont pay.

in books they always book bad debts when debtor becomes insolvent.

 

regards

 

Hi shivani,

If debtor is simply saying he won’t pay the balance, in my opinion, we can’t book the difference as bad debt as long as we have a legal right to enforce our claim through the court of law and more importantly, we plan to sue the debtor. Our decision, relating to whether to go to the court, may depend on many things like the quantum of amount involved etc. in the above case, If we don’t plan to initiate legal proceedings, then certainly, the difference is bad debt and can be booked accordingly.

A person cant declare himself as an insolvent, but he has to file insolvency petition in the court and normally, the list of persons to whom he owes money and their respective amounts will be circulated among his creditors and after getting their representations through their advocates, the court may declare such a person as insolvent and discharge from his liabilities and the amount due to the creditors will be proportionately settled from the sale proceedings from his estates, if any, under the supervision of the court.

I’m not sure, whether there are any additional procedures, but these are the basic procedures relating to insolvency. The pivotal point here is that there is a long time gap (may be 3-4 years or even more when the number of creditors is large) between the person filing IP petition and declaring him as insolvent.

 Moreover, some amount may be recovered from him ultimately from his estate, even if we don’t know the exact recoverable amount at the time of his filing petition. That’s why, I’m saying we can’t write off fully the outstanding balance at that time, in the absence of adequate information. Therefore, we have to make a provision for the full outstanding balance at time of filing his petition and when he becomes a declared insolvent, we should reverse the full provision and debit bad debts for the amount that has become irrecoverable.

1. Bank a/c               Dr           (Recovered Amount)

    Baddebts             Dr             (Irrecoverable amount)

    To debtor

 

2. Provision for bad debts

    To P&L

 

But as per Income Tax Act, we can claim bad debts, if we have simply written off it in our books of accounts. There doesn’t require any conclusive evidence that the amount has actually become irrecoverable. In many cases, courts have taken the view that evidence is not necessary for writing off the outstanding balance as bad debts; rather the assesee merely require to actually writing off the amount as bad debts in his books of accounts. That’s the reason why, in practical cases, we immediately write off the debtor balances as bad debts, as and when it become merely doubtful; as it is an admissible deduction for income tax purpose. But this is a sort of concession given in Income Tax Law and is not strictly in accordance with the accounting theory. We have to understand, all what we do for tax purpose may not be correct from accounting point of view.

 

Dear Vivek

 

correct me if i have understood wrong.

 

 

case 1

debtor says i wont pay and we dont plan to sue

Bank 6000

bad debts 4000

     to Debtor 10000

 

Case 2 debtor says i wont pay. We plan to sue

Bank 6000

   to debtor  6000

 

Profit & Loss 4000

   to provison for bad debts 4000

(this entry at year end OR at the time when he pay 6000, please clarify?????)

 

Now suppose we get only Rs. 1500 out of remaining Rs. 4000 from court.

 

how will rest of entries be passed?

 

thanks

 

 

 

 

Case 1: Your entry is correct

Case 2: Entry is correct. Since any anticipated loss has to be recognised immediately, we have to make provision as and when the collection of outstanding balance becomes doubtful and not at the year end. So in the present case, not at the time when he pays 6000; but, as an instance, when he says he wont pay the balance.

When 1500 received from court

1. Reverse the full provision created earlier

Provision (Dr)   4000

To P&L   (Cr)    4000

2. Writeoff the irrecoverable amount as bad debts

Bank          (Dr)  1500

Baddebts   (Dr )  2500

To Debtor (Cr)    4000

---------------------------------------------------------------------------------------------------------------

Case Closed..!! 

Dear Vivek

 

if we continue with your reply further and suppose in case 2 where we got only rs. 1500 from court.

i need to know about Bad Debt Recovery Account we study in our academic books.

will  bad debt recovery account be opened if out of rs. 2500 that we booked debtor pays later some amount ?

 

regards