Provision for doubtful debt or bad debt provision refers to the portion of a company’s total asset, which represents a certain percentage of its accounts receivable, considered to be uncollectible. It is the amount that a company estimates it will not be able to recover from customers for services provided or products sold and serves as a risk management tool.
• This provision acts as an expense that a company incurs due to the probability of non-payment of accounts receivable.
• Helps in creating an accurate depiction of a company’s financial position and ensures that the accounts receivable are shown at a realistic figure in the balance sheet.
Bad Debt Write-off
• This happens when a company writes off a specific customer’s account as irrecoverable. It means the company believes that it cannot collect any further payments from that particular customer.
• Writing off bad debt can result in a permanent loss of revenue and affects the company’s overall profitability.
Key differences:
1. Nature
-Provision for doubtful debt: Estimate of potential bad debts based on historical data and credit risk assessment
-Bad write-off: Specific and actual debt considered irrecoverable
2. Timing:
-Provisions for doubtful debt: Recorded as a current or long-term expense on the income statement
-Bad write-off: Removed entirely from the accounts receivable and recorded as an expense at the time it is written off
3. Impact on financials:
-Provisions for doubtful debt: Reduce the value of assets and profits by expense, but the cash balance is unaffected.
-Bad write-off: Decreases both the accounts receivable assets and the revenue, resulting in a direct impact on cash flow.
4. Frequency
-Provisions for doubtful debt: Ongoing process throughout the accounting period
-Bad write-offs: Occur sporadically when specific debts are deemed uncollectible
5. Reporting
-Provisions for doubtful debt: Presented as a contra-assets on the balance sheet, offsetting accounts receivable
-Bad write-off: Reported as an expense on the income statement in the period when they are written off
In summary, provisions for doubtful debt serve as proactive risk management measure to cover the potential losses, while bad debt write-offs represent the specific realization of unrecoverable debts. While they are both related to uncollectible accounts, their accounting treatments and financial impacts differ.