At the end of the year, after writing off the bad debts about whom we were sure of becoming irrecoverable, there may still be some customer balances from whom it is doubtful to collect the entire amount. However, it can’t be written off as bad because non-recovery of such amount is not certain. But at the same time the balance in sundry debtor’s account should be brought down to its net realizable figure so that balance sheet may not exhibit the debtors at more than their actual realizable value. Therefore, to show the approximately correct value of the sundry debtors in the balance sheet a provision or reserve is created for possible bad debts. Such an adjustment entry is recorded at the end of accounting year.
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Provision for bad debts is an attempt to anticipate possible losses due to bad debts and to keep aside an amount out of profit to meet the loss estimated in the following years.