Different Methods Of Creating Provision For Doubtful Debts

METHOD 1: GENERAL PROVISION BASED ON AS % OF CLOSING TRADE DEBTORS BALANCE

This methodology is normally called general provision for doubtful debts

The term general is because there is NO SPECIFIC identification of the trade debtors who has really turn back.

This estimate is based on past trend or management in-depth understanding of the industry

Illustration:

Say, at Year End Trade Debtors Balance  is $5,000,000

Based on experience, Management decided to create a provision of 1% on the year end trade debtor balance::

1% x $5,000,000=$50,000 by:

Debit: Provision for Doubtful Debt ( Income Statement)  $50,000

Credit: Provision for Doubtful Debt ( Balance Sheet)       $50,000

Being 1% general provision created based on year end trade debtor balance

METHOD 2: GENERAL PROVISION BASED ON AS A PERCENTAGE OF WHOLE YEAR BILLINGS

Similar explanation as above.

The difference is that we are only taking an estimate based on the whole year billing. This estimate is based on past trend or management in-depth understanding of the industry

Illustration:

Say, whole year revenue is $10,000,000

Based on experience, we create a provision of 0.5% of the whole year revenue :

0.5% x $10,000,000=$50,000 by:

Debit: Provision for Doubtful Debt ( Income Statement)  $50,000

Credit: Provision for Doubtful Debt ( Balance Sheet)       $50,000

Being 0.5% general provision created based on whole year’s revenue

METHOD 3: AS SPECIFIC PROVISION BY IDENTIFY SPECIFIC CUSTOMERS WHO TURNS BAD

The word SPECIFIC means that this provision is created based on reviewing the INDIVIDUAL trade debtor who are owing to the company.Say there is 100 trade debtors owing, management at certain interval will review individually the trade debtor account and believe that only 10 accounts needs to be selected  for doubtful debt.

Unlike the aforesaid general provision, these specific provisions might be based on documentary evidence like litigation and other investigations that prove that the debtors might turn bad hence the need to create the specific provision

As for as the accounting treatment is concerned, it is the same as the general provision. ( see illustrations above)

METHOD 4: BASED ON DETAILED AGEING SCHEDULE

In this case, this provision for doubtful debt is creating from the AGEING Trade Debtors Schedule. Every month, management are presented with such AGEING schedule which reflects the AGE of these trade debtors. Based on company’s internal policy /procedures, the provision for doubtful debt is created.

Illustration:

Assuming that Company A has the following accounting policy & procedure for provision for doubtful debt:-

Trade Debtors >120 days – 10%of trade debtors amount

Trade Debtors >180 days old  50% of trade debtors amount

Trade Debtors >365 days   – 100 % of trade debtors amount

Instead of looking at the AGEING schedule,

: provision for doubtful debts can also be created based on a review of the OVERDUES BALANCES