Funds from Operations - Reserve for Bad and Doubtful Debts

In general, creation of any Reserve amounts to appropriation of profits.
Creating General Reserve Dr. Profit and Loss a/c
Cr. General Reserve a/c
Non-Current
Non-Current

Bad Debt Reserve is also created by appropriating profits. However, for the purpose of funds flow analysis, this transaction is treated as a cross transaction involoving nominal accounts and thus the debit to the profit and loss account is considered a charge against profits.

Creating Bad Debt Reserve Dr. Profit and Loss a/c
Cr. Reserve for Bad and Doubtful Debts a/c
Non-Current
Current

Why is it a charge?

The prefix 'Reserve' in Reserve for Bad and Doubtful Debts creates an understanding that the transaction amounts to an appropriation of profit and not a charge.

A transaction resulting in a debit to the profit and loss can be claimed to be an appropriation if the account to which the profits are being transferred is a part non-current liabilities in the balance sheet.

Therefore, creation of reserve for bad and doubtful debts can be treated as an appropriation if the Reserve for Bad and Doubtful Debts account is a non-current liability in the balance sheet.

Where is Bad Debt Reserve positioned in the balance sheet?

In making up a balance sheet, we conventionally deduct the balance in the reserve for bad and doubtful debts account, from the value of debtors on the assets side of the balance sheet.

Deducting an item from the assets side is the same as placing the item on the liabilities side.

Assuming that the balance sheet is marshalled, since Sundry Debtors are Current Assets, the reserve related to it would be a Current Liability. Thus Reserve for Bad and Doubtful Debts is treated as a current account.

Any transaction resulting in a debit to the profit and loss account wherein the other account involved is a current account results in a charge on profits.

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