What is a provision for bad/doubtful debts?
Back to some basics today, seen as it is almost the beginning of a new academic year for me. I’d like to provide a brief summary of the notion of a provision for bad debts – based on my experience as an accountant mainly, but of course, it is something I would teach too.
First, a provision in accounting is simply an entry for something that has not yet happened but is probable. So, when a business sells on credit, it is likely some portion of customers will not pay – regardless of how good the credit controls are. Thus, based on past experience usually, the accountant in a business will create a provision for bad debts (sometimes called doubtful debts, or irrecoverable debts). At this stage, no specific debt which may be unpaid is identified, it is just a general estimate and the amount is captured as an expense in the income statement of the business. In my experience, the amount set by as a provision in the financial statements is typically about 1-3% of the amount of outstanding receivables, although this can vary from time to time. any adjustments to the amount provided are reflected through the income statement. When a debt is actually identified e.g. a customer goes bankrupt, then this specific amount is a separate expense to the income statement. Such specific debts may cause an accountant to review the amount of the provision too.