A firm is maintaining a provision for bad debts at 5% of debtors and a provision for discounts at 2.5%. If at the end of a year, debtors amounted to Rs. 20,000 the provision for discounts will be :

Question

Accepted Answer

The correct option is 3:
This problem requires the sequential application of accounting principles, particularly the Prudence Principle, for determining various provisions. In standard financial accounting, the Provision for Discount on Debtors must always be calculated on the amount of debtors considered 'good' or expected to pay, which is the balance remaining after deducting the Provision for Bad Debts. The logical flow is as follows: first, calculate the Provision for Bad Debts (5% of Rs. 20,000 = Rs. 1,000). Second, ascertain the Net Debtors (Rs. 20,000 - Rs. 1,000 = Rs. 19,000). Third, apply the discount rate to this net figure: the Provision for Discounts is 2.5% of Rs. 19,000, which correctly equals Rs. 475.

The incorrect option is 1:
Rs. 500 is the result of calculating the 2.5% provision for discounts on the gross debtors amount of Rs. 20,000 (Rs. 20,000 x 2.5% = Rs. 500). This approach is flawed because it ignores the fact that a discount would never be offered to a debtor who is already classified as a potential bad debt. Therefore, calculating the discount provision on the total debtors amount overstates the estimated expense and violates the fundamental accounting convention of prudence, which dictates that expenses should not be underestimated.

The incorrect option is 2:
Rs. 1,000 is the correct calculation for the Provision for Bad Debts only (5% of Rs. 20,000). This option acts as a common distractor, catching students who confuse the percentage rates or who stop the calculation after completing the first necessary step. While the provision for bad debts is Rs. 1,000, the question specifically asks for the amount of the provision for discounts.

The incorrect option is 4:
Rs. 750 represents an amount that is not derivable from the correct, standard accounting method. It is likely the result of an arbitrary or complex arithmetical error made by incorrectly applying the given rates and base values. It does not correspond to a logical stage in the provision calculation process, such as the gross or net provision for either bad debts or discounts.