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  1. 023A customer who owes your company Rs 50 lakh goes bankrupt and will pay nothing. Walk the write-off through the three statements at a 25% tax rate, first when no provision was held against the debt, then when a full provision was booked last year.Accounting flow riddlesWarm upBig FourCorporate FP&A

    Try it first

    A full provision for this debt was booked last year. How much does this year's net income fall when the debt is written off?

    Show the worked solution

    Without a provision, net income falls Rs 37.5 lakh; with a full provision already booked, it does not move. With no provision, the Rs 50 lakh is an expense, tax falls Rs 12.5 lakh, and net income falls 37.5. Cash rises 12.5 from lower tax, receivables fall 50 and retained earnings fall 37.5. With a provision booked last year, the write-off only removes the debt and the provision together, so profit and cash are unchanged.

    What happens when nothing was set aside?

    Think of a shopkeeper with a customer who has run up a tab and then left town. The money was counted as owed; now it never will be. Writing off a debt with no provision turns an asset into an expense in one step: receivables fall Rs 50 lakh and a bad debt expense of Rs 50 lakh hits profit. Assuming the write-off is tax deductible, tax falls Rs 12.5 lakh, so net income falls Rs 37.5 lakh. On the cash flow statement, add back the Rs 50 lakh because no cash moved; cash from operations rises Rs 12.5 lakh, the tax saved. The balance sheet balances: assets fall 37.5 (receivables down 50, cash up 12.5) and retained earnings fall 37.5.

    The loss is booked when it becomes likely, not when the customer failsNo provision heldIncome statementBad debt expense-50Tax at 25%+12.5Net income-37.5Cash flowAdd back write-off+50Cash from operations+12.5Balance sheetReceivables-50Cash+12.5Retained earnings-37.5Full provision booked last yearIncome statementNo entry this year0Net income0Cash flowNo entry this year0Balance sheetGross receivables / provision-50 / -50Net receivables0Profit fell 37.5 last year,when the provision was bookedRs lakh. Assumes the write-off is tax deductible when it happens; confirm the rule where the company files tax.
    With no provision held, writing off Rs 50 lakh cuts net income by Rs 37.5 lakh after tax and raises cash by Rs 12.5 lakh of tax saved. With a full provision booked last year, the write-off removes the debt and the provision together, so neither profit nor cash moves this year.

    Why does the provision case show nothing this year?

    Because the loss was already recognised. A provision for doubtful debtsAn amount set aside against receivables the company expects not to collect. It reduces net receivables on the balance sheet and is charged to profit when it is created. is booked when a loss becomes likely, and that is when profit takes the hit. Accounting recognises a loss when it becomes probable, not when the customer finally fails, so the write-off later is a tidy-up between two balance sheet lines. Gross receivables fall Rs 50 lakh, the provision against them falls Rs 50 lakh, and net receivables are unchanged. Under Ind AS 109 and IFRS 9 companies provide for expected credit losses in advance, which is this logic applied to a whole loan book.

    The relationship
    ΔNI=−50×(1−0.25)=−37.5ΔCash=+50×0.25=+12.5\Delta NI = -50 \times (1 - 0.25) = -37.5 \qquad \Delta\text{Cash} = +50 \times 0.25 = +12.5
    50the debt written off, Rs lakh
    0.25tax rate
    ΔNIchange in net income with no provision held
    What it says in wordsWithout a provision, profit falls by the after-tax loss and cash rises by the tax saved.

    What about tax in the provision case?

    This is the follow-up that separates good answers. In many tax systems a general provision is not deductible until the debt is actually written off, so the tax saving arrives now even though the expense was booked last year. The books handle that with a deferred tax asset created last year and reversed this year: cash tax falls Rs 12.5 lakh now, with no effect on this year's profit. Treat the rule as something to confirm for the jurisdiction where the company files tax, rather than a fixed fact.

    Where candidates lose it

    The common loss is putting the Rs 50 lakh through profit again in the provision case, which counts the same loss twice: once when the provision was made and again on write-off.

    The second loss is in the no-provision case: saying cash falls by 50. No cash moved when the customer failed; the cash was never received. The only cash effect is the tax saved.

    What the interviewer asks next

    • The provision booked last year was only Rs 30 lakh. Walk the write-off through now.
    • The customer later pays Rs 10 lakh after all. What happens in each statement?
    • How would a rising provision show up in a company's cash flow statement?