To increase the sales, businesses may grant credit facilities to its customers. These customers become debtors, as they owe the money to the business. As long as you have debtors, there is always a percentage of these debtors who may not be able to pay their accounts. Some debtors may, by nature, have an unwilling tendency to pay their debts. Other debtors may become insolvent or bankrupt, etc.

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, 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→Debtor menu option, if you create or edit Debtor accounts. Use credit limits to keep your debtor accounts within your credit agreement.
• Send Debtor Statements regularly to your Debtors.
• Utilise the Debtors Age Analysis Reports to follow up outstanding amounts 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 is calculated on the good book debtors. Before you can actually start to calculate provision for bad debts, you need to first identify those bad debts, which are irrecoverable and write the bad debts-off. You may have written bad debts-off during the course of the financial year.

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 three methods to calculate the provision for bad debts or doubtful debts, i.e.

• Estimates or calculations based on the age analysis schedules of your debtor accounts.
• Estimates or calculations based on the total outstanding debt.
• 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 as current assets, in the Balance Sheet, is shown as follows:

An extraction of the Debtors and Provision for Bad Debts, as current assets, in the Balance Sheet generated in TurboCASH is shown as follows:

An extraction of the Debtors and Provision for Bad Debts, as current assets, in the Trial Balance is shown as follows:

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/GST/Sales Tax and other purposes.

- In larger business entities, 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 an annual basis.