How to record a provision for doubtful debts

Step by step

1. Write off any known bad debts first. Remove irrecoverable debts before calculating the provision, so it is based on the remaining receivables.
2. Calculate the required provision. Apply the percentage to the trade receivables figure after write-offs.
3. Compare with last year's provision. Find the difference between the new provision and the existing one.
4. Charge only the change. An increase is an expense. A decrease is added back as income in the income statement.
5. Show the provision in the statement of financial position. Deduct the full provision from trade receivables to show the net figure.

Worked example

Receivables are RM10,000 and the provision needed is 5%, which is RM500. If last year's provision was RM400, only the RM100 increase is charged.

Understanding the method

When a business sells on credit, some customers will not pay, even if it cannot yet say which ones. Prudence says profit should not be overstated, so it would be misleading to show every receivable as certain to arrive.

The matching concept says the likely loss should be recorded in the same period as the sales that caused it. The provision does both.

A bad debt written off is a specific debt that is now known to be irrecoverable. The customer's account is closed and the amount is an expense. A provision is a general estimate against debts that still exist and may yet be paid, so no customer account is touched.

The order matters. Write off the certain losses first.

Then calculate the provision as a percentage of the remaining receivables. Only the change in the provision from last year passes through the income statement.

Here is an example. Trade receivables are RM52,000, and one customer's RM2,000 is irrecoverable and written off. That leaves RM50,000.

The business provides 5%, so the required provision is RM2,500. Last year's provision was RM1,800, so the provision rises by RM700.

The income statement shows two items: the RM2,000 bad debt written off and the RM700 increase in the provision. The statement of financial position shows receivables of RM50,000 less the full provision of RM2,500, a net RM47,500. This is the amount likely to be collected.

If the required provision falls, the reduction is added to income. Sometimes a provision is created for the first time, so the whole amount is the change.

To check, last year's provision plus the movement you charged must equal the closing provision: 1,800 + 700 = RM2,500. Also check that the percentage was applied after the bad debt was written off.

Common mistakes: charging the whole RM2,500 to the income statement instead of only the RM700 change, and treating a decrease as an extra expense. Others are deducting the bad debt twice from receivables, and applying the percentage before writing off the bad debt, which inflates the provision.

If the write-off and provision steps blur together in your answers, one of our teachers can separate them with you and practise the change-in-provision calculation on past papers. Book a trial class

Related skills

• How to write off an irrecoverable debt
• How to prepare an income statement for a sole trader
• How to prepare a statement of financial position

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.