Bad debts- provision vis a vis write off

[C.A. DEV KUMAR KOTHARI]

Basic theory"

Going to the basics of book-keeping, as studied for Madhyamic Examination1972 (class IX and X), author recalls two types of provisioning or write-off bad-debts namely:

a. Making provision as a percentage of sundry debtors,

b. Writing off particular debtors.

Making provision as a percentage of sundry debtors:

In category a. the amount of sundry debtors as on the balance sheet date is considered and certain percentage of it is considered as provision required as on balance sheet date. In case the balance of provisions for sundry debtors brought forward is lower, balance amount was provided in accounts to make provisions equal to decided percentage of sundry debtors. In case balance brought forward is higher than the amount required as on balance sheet date, then excess was written back. In this method any attempt as to real nature of sundry debtors was not made. However, in case of advanced accounting various classes of sundry debtors are considered and different percentage of provisioning is applied. For example for normal sundry debtors (not due for more than three months say 1%, for sundry debtors over due for more than three months say 3% and sundry debtors over due for more than one year say 5%).

These can really be considered as provision based on certain parameters and not as per real specific situation in relation to any sum recoverable or not recoverable from particular sundry debtors or other recoverable sums.

Writing off particular debtors.

In b. category bad debts are written off for specific sundry debtors by ascertaining the amount unrecoverable.Sometimes instead of mentioning them as bad debts written off, the same they are considered as provisions and reduced from the amount of sundry debtors. This is to keep a track and make attempt to recover at later date as and when some possibility to recover the sums arise. In some cases full amount may be written off / provided and in some cases part amount may be written off /provided. In reality we find that such provision though described as provision, in reality they are in nature of unrecoverable sums and hence bad debts.

Separate record for possibility of recovery:

The author remember that his commerce teachers great Jethmal Ji Kiradu, great Prahald Rai Ji Kiradu and Shri Hanuman Prasad Ji Sharma has taught that merely selling goods on credit is not enough, real income is earned when money is received, therefore, one should not forget money receivable after writing it off. In future the customer, may himself come and pay when he is in better position. Therefore, it was also taught that a separate register for sums written off with complete details and supporting documents can be maintained separately for monitoring. In case a money suit is filed these documents are handed over to advocates.

Now, in practice also author so advise and also we find that many clients maintain records of sundry debtors ( may be for larger sums and ignoring smaller ones) which are written off based on situation prevailing as on balance sheet date. Separate record is maintained to keep a watch of possibilities of recovery in future. Considering litigation which the word 'provision', may cause it is advisable that the sum should be written off from main books of account, and separate record for such sums written off may be kept for exploring possibility of recovery as and when circumstances of debtor improves.

Accounting presentation:

Under specific applicable provisions of law or accounting methods adopted or as per specific circumstance a sum may be shown as provision though it may be in nature of unrecoverable sum. The accounting presentation is therefore not conclusive or determinative of real aspects. An amount may be shown as provision as a deduction from sundry debtors, yet it may be a bad-debt. Factors like recovery or non recovery of the sum in near future say six months can be considered sufficient as to whether the sum was in nature of unrecoverable as on balance sheet date.

Adjustments in computation of income:

Normally when there is provision and the provision is not allowed the following adjustments need to be made in computation of income:

a. Disallow provision made during the year, if any,

b. Allow bad debts written off against provision, which was not allowed,

c. Deduct excess provision written back in P & L which was not allowed while computing income in earlier years.

Recovered sum is income:

When any sundry debtor is written off and allowed as a loss while ascertaining taxable income, any amount received against such debtor, in future is considered as income u/s 28, 41.

Recent judgment of Supreme Court:

The SUPREME COURT OF INDIA in T. R. F. Ltd. v. CIT 2010] 1 taxmann.com 106 (SC) considered these aspects. And held inter alia on the following lines:

1. that for purpose of section 36(1)(vii) post 1-4-1989, it is enough if bad debt is written off as irrecoverable in accounts of assessee,

2. when bad debt occurs, the bad debt account is debited and the customer's account is credited, thus, closing the account of the customer.

3. However, in the case of Companies, the provision is deducted from Sundry Debtors.

However, in the case before the Supreme Court , the Assessing Officer has not examined  whether the debt has, in fact, been written off in accounts of the assessee, therefore the matter has been restored for the limited purpose of ascertaining whether the debts were written off.

The Supreme court held that " When bad debt occurs, the bad debt account is debited and the customer's account is credited, thus, closing the account of the customer. In the case of Companies, the provision is deducted from Sundry Debtors."

It seems that in the case before the Supreme Court also the amount was shown as provision deducted from sundry debtors in the balance sheet of assessee who is a company. Yet the Supreme Court has directed the AO to examine these aspects. In this case, it appears that, if the amount is ascertained for specific sundry debtors, then the amount written off will qualify as bad debt, though described as provision for bad debts.

Simplicity is required:

No business person want that his debts should turn bad and unrecoverable. However, in reality this happens due to several factors associated with national and international economy, financial conditions of industry in which debtors are engaged, financial condition of debtors etc. Many times the industry as a whole or debtor makes a turn-around in its operations, and it is possible to recover the sum in future. Accounts have to be prepared based on reasonable estimates as on balance sheet date. Therefore, factors prevailing on such date are considered. In context of overall income and sundry debtors, the revenue, bad debts of assesses is not a big factor. If an assessee has large bad-debts, and there is no control, he cannot run business for a long period. Therefore, matters relating to bad debts or its provisions should be left to the assesses. The accounts may be relied on for allowing the same and considering recovery in future as income. There is not much impact on revenue, however, there is lot of litigation on these aspects. Therefore, the provisions on these aspects should be simplified. We find that even after so called simplification, in provisions, there are lot of ambiguities and scope for litigations.