Provision Formulas

Provision Formulas

Provision is created for a current liability, which would be confirmed in future. The provision is recognized on the best estimates. Provision is calculated as percentage of some relevant factor i.e. (sales, accounting Profit).  Some famous provisions are;

1.   Provision for warranty

2.   Provision for Tax

3.   Provision for Doubtful Debt

Formulas of these provisions have been given below. These formulas have been explained in more details with examples in my other articles.

Provision for Warranty Formula

Provision for Warranty  = % of Warranty x Sales

Provision for Warranty Formula Example

Sales (Year 2001) = 200,000

Warranty Required = 10% of Sales

How much provision is required?

Solution

Warranty = % of Warranty x Sales

= 10% x 200,000

=20,000 (Provision for warranty)

Provision for Tax Formula

Provision for Tax =Tax Rate x Accounting Profit

Provision for Tax Formula Example

Profit before Tax = 250,000

Tax rate = 30%

What would be the provision for tax?

Solution

Provision for tax =Tax Rate x Accounting Profit

= 250,000 x 30%

=75,000 (Provision for tax)

Provision for Doubtful Debt Formula

Provision for Doubtful Debt = % of Doubtful Debt x Account Receivable

Provision for Doubtful Debt Formula Example

Account Receivable Closing balance = 100,000

Allowance for doubtful Debt = 10%

Calculate allowance for Doubtful debt?

Solution

% of Allowance for Doubtful Debt x Account Receivable

=10% x 100,000

=10,000 (Allowance for Doubtful Debt)

Provision for Income Tax

Provision for Tax

provision for tax is calculated on the bases of the accounting profit. Actual tax calculation may be different from the provision made, because final tax expense is decided by tax authority . it means there may be under or over provision for tax. 

Provision for tax =Tax Rate x Accounting Profit

Provision for Tax Formula Example

Accounting Profit for Year = 150,000

Tax Rate = 40%

What would be the provision for tax?

Solution

Provision for tax =Tax Rate x Accounting Profit

=150,000 x 40%

=60,000 (Provision for tax)

 Provision for Tax Journal Entry

Date	Particulars	Debit	Credit
	Tax A/c	60,000
	Provision for Tax A/c		60,000

Provision for Tax Formula Example (Under Provision)

Accounting Profit for First Year     = 200,000

Accounting Profit for Second Year = 300,000

Tax Rate = 40%

Actual Tax in Second Year            = 90,000

What would be the provision for tax?

Solution

Provision for tax =Tax Rate x Accounting Profit

=200,000 x 40%

=80,000 (Provision for tax)

 Provision for Tax Journal Entry (First Year)

Date	Particulars	Debit	Credit
	Tax A/c	80,000
	Provision for Tax A/c		80,000

Provision for Tax Journal Entry (Second Year)

There will be two tax related entries in second year i.e. tax payment and second is provision creation.

First Entry

In first entry tax payment is made and under provided amount is charged to profit & loss account.

Date	Particulars	Debit	Credit
	Provision for Tax	80,000
	Tax (profit & Loss)	10,000
	Cash		90,000

Second Entry

In second entry provision is created for the year based on accounting profit.

Date	Particulars	Debit	Credit
	Tax A/c	120,000
	Provision for tax		120,000

It is to  be noted that in case of under provision (for last Year), tax expense for the current year increased by the amount of under provision.

Tax Expenses (under Provision)           10,000

Provision for Year                            120,000

Total Tax                                        130,000

Provision for Tax Formula Example (Over Provision)

Accounting Profit for First Year      = 200,000

Accounting Profit for Second Year = 300,000

Tax rate = 40%

Actual tax in second Year = 60,000

What would be the provision for tax?

Solution

Provision for tax =Tax Rate x Accounting Profit

=200,000 x 40%

=80,000 (Provision for tax)

 Provision for Tax Journal Entry (First Year)

Date	Particulars	Debit	Credit
	Tax	80,000
	Provision for Tax		80,000

Provision for Tax Journal Entry (Second Year)

First Entry

Date	Particulars	Debit	Credit
	Provision for Tax	60,000
	Cash		60,000

Second Entry

Date	Particulars	Debit	Credit
	Tax A/c	100,000
	Provision for tax		100,000

It is to be noted that due to over provision in last year, the current tax expense would be reduced by such amount.

Provision required for Year                 120,000

Unused Balance                                (20,000)

Provision Charged                             100,000

Over Provision for Income Tax

Over Provision for Income Tax

Provision for income tax may be under or over estimated. When tax provision is greater than actual tax expense, then provision is called over provision  for tax. In other word , when Actual expense is lower than provisioned amount, then provision for tax is said to be over (Over provision for tax).

Over Provision = Provision Created- Actual Expense

Actual Expense < Provision created = Over provision

110,000> 140,000= 30,000 (Over provision)

 Accounting Treatment of Over Provision

Over provision would reduce or decrease the tax expenses for the year, because previously higher amount was charged to profit & loss, now those estimate needs to be revised, because actual tax payment figure are available. Over provision would reduce the tax expense in the next year (when actual tax is paid). Accounting Treatment of over provision for tax has been explained below with an example.

Over provision Example

Tax rate for the year = 40%

Profit for the year = 500,000

Actual tax = 150,000

Calculate under or over provision and pass journal entry?

Solution

Provision for tax = 40% x 500,000= 200,000

Provision tax = 200,000

Actual Tax    = 150,000

Over provision = 50,000 ( provision > Actual Tax Expense)

First Year (Provision Created)

Date	Particular	Dr.	Cr.
	Tax	200,000
	Provision for Tax		200,000

Second Year (Tax Paid)

Over provision in last year would reduce the tax expense. you can see the tax amount is being credited (reduced) in below entry.

Date	Particular	Dr.	Cr.
	Provision for Tax	200,000
	Tax Expense		50,000
	Cash		150,000

Over provision Example

Tax rate = 40%

Profit (first Year)   = 500,000

Profit Second Year = 700,000

Actual tax Paid in second year = 150,000

Calculate under or over provision and pass journal entry?

Solution

Provision tax = 200,000

Actual Tax     = 150,000

Over provision = 50,000

First Year

Date	Particular	Dr.	Cr.
	Tax A/c	200,000
	Provision for tax		200,000

Second Year

First Entry (Tax Paid)

Date	Particular	Dr.	Cr.
	Provision for Tax	150,000
	Tax Expense		50,000
	Cash		150,000

Second Entry (Provision Created )

Date	Particular	Dr.	Cr.
	Tax	280,000
	Provision for Tax		280,000

Total expense for Year

Current year provision          280,000

Less: Over provision              50,000

Total  Tax Expense               230,000

We can note that though provision in second is created, but tax expense is lower than provision created (due to over provisioning in last Year).