A business normally writes these debts off as irrecoverable for various reasons. This decreases the value of the outstanding debtors' accounts. Provision for bad debts are created because of the uncertainty regarding debtors settling their debts. Some people may refer to bad debts as irrecoverable debts and the provision for bad debts as provision for irrecoverable debts or even provision for doubtful debts.
To keep the amounts written-off as bad debts and to make fair and reasonable estimates of provision for bad debts or irrecoverable debts, the some of the following considerations should be taken in account:
Credit Control when granting credit facilities - If you have not carefully checked the credit worthiness of your debtors (on application for credit), your risk for bad debts will most probably, be very high (much higher than the bad debts of your competitors who have screened their debtors carefully). All the relevant information and credit agreement terms and conditions needs to be entered accurately on the Edit - Accounts - Debtors menu option if you create or edit Debtor accounts. Use credit limits to keep your debtor accounts within your credit agreement.
Send Debtor Statementsregularly to your Debtors.
Utilise the Debtors Age Analysis Reports to
follow outstanding amounts up and send reminders, letters of demand, etc.
You may also allow early settlement discounts to encourage your debtors to pay or settle their accounts promptly.
Provision for Bad Debts or Doubtful Debts are usually done at the end of your financial year, before you do a year-end (close the books). Once you have created provision for bad debts (in the fist year of your business existence or implementation of accounting policy), you need to revise and adjust the provision from year to year. To revise the provision, you may have to increase the provision or decrease the provision in the second year and onwards.
To create provision for bad debts, increase or decrease any provisions for bad debts is a separate transaction to that of writing off of physical irrecoverable or bad debts. There are basically 3 methods to calculate the provision for bad debts or doubtful debts, i.e.
Estimates or calculations based on the age analysis schedules of your
Estimates or calculations based on the total outstanding
- Estimates or calculations based on the total sales on credit.
Provision for bad debts are regarded as a contra asset or negative asset because it has a credit balance. An extraction of the Debtors and Provision for Bad Debts in the balance sheet as current assets as follows:
In TurboCASH it would be displayed as follows: In the Balance Sheet:
In the Trial Balance:
If you make provision for bad debts, you should generally speaking already have had some problems with collecting funds from your debtors. If you have written off or before you decide to write-off bad debts, you should have proof of the efforts (documentation, letters, requesting final payment, etc.) which you have made to collect the debts. This is necessary since, the Tax Authorities may require it for Income Tax, VAT and other purposes. Click in the speed button of the Help File and select the Web Address of your Tax Authority to browse the Web Site for more information.
In larger concerns, the provision for bad debts or doubtful debts may be done on a regular basis (e.g. monthly or a six monthly basis), while most businesses makes provision on a annual basis.