provision for bad debt account
The provision for bad debt account, also known as the allowance for doubtful accounts, is an accounting concept that deals with the recognition of potential losses due to customers' non-payment of their outstanding debts. It is a contra-asset account that reduces the accounts receivable on the balance sheet.
To calculate the provision for bad debt, you typically follow these steps:
1. Determine the historical percentage of bad debts: Review past records and identify the average percentage of bad debts based on your industry or historical data. For example, if historically 5% of your sales have resulted in bad debts, you would use this figure for your provision calculation.
2. Assess the aging of accounts receivable: Analyze the outstanding accounts receivable by considering the age of the debt. Generally, the older the receivable, the higher the likelihood of non-payment. Categorize them into different age groups, such as current, 30 days past due, 60 days past due, etc.
3. Estimate the potential loss: Apply the historical percentage of bad debts to each age group of accounts receivable. For example, if 50% of receivables aged 60 days result in bad debts, you would estimate a potential loss of 50% for that specific group.
4. Calculate the provision: Multiply the estimated potential loss for each age group by their respective outstanding amounts and sum them up. This will give you the total provision for bad debt to be recorded in the provision for bad debt account.
It's important to note that the provision for bad debt is an estimate and may require adjustments based on changes in economic conditions or individual circumstances of the customers. The purpose of this account is to reflect the potential risk of non-payment and provide a more accurate representation of the company's financial position.