#103- Provision for Doubtful Debt

We received queries from one of our blog readers in relation to provision for doubtul debt. We will summarize her queries as below:

a. Is general provision for doubtul debts still allowable? If a client provides an allowance of 60k per year as doubtful debt where the double entry is Dr. bad debts Cr. Provision for doubtful debts - is this practice still allowable?

b. Which IAS standard govern this area

Response from myauditing.blogspot.com

a. No. General provision is no longer allowed. IAS 39 states provision for doubtful debt is required when there's objective evidence that the receivable amount is no longer recoverable. As such, only specific provision is allowed. For accounting entries, it is Dr. Bad Debts Expense, Cr. Provision for Doubtful Debt

b. IAS 39

#90- Review of Credit Term

One of the audit procedures to be performed while reviewing trade debtors balance is to review the credit term given to the customers (i.e. debtors).

To illustrate, we can obtain list of trade debtors, including: credit term given to respective trade debtors, and compare the credit term given to the norm of the industry. We would inquire our audit clients, if credit terms given are unusually long.

For instance, the norm of the credit term in industry A is 90 days. ABC company ( our audit client) allows a credit term of 180 days to customer XYZ. We will have to find out the underlying business reason of giving relatively longer credit term, and evaluate the collectibility of amount owing from customer XYZ.

Analyzing credit term given can be used as a useful tool in understanding the credit policy of our audit client.

#72 Debtors Turnover Analaysis

In auditing debtor balance, auditor will perform some analysis of the debtors turnover of the audit client, and compared the result to prior year to identify unusual fluctuations.

Debtors Turnover (day) is computed as below:

Average Debtor Balance / Sales x 365 days = Debtor Turnover (day)

Debtors turnover ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year.

We will expecting a deteriorating debtor turnover (day) in this gloomy economy environment. To illustrate with an example, a customer of our audit client would take longer period to repay its outstanding balance due on time, and herein increase the number of day the receivable stays in the debtors balance.

Customers are squeezing their creditors by pro-longed their repayment period. Our audit client may, in another leg, delay the repayment to its (audit client's) suppliers.

A economy efficient would have been created, as the delaying in repayment has direct impact on the ultimate's suppliers decision on resource allocation. In afraid of selling items to doubtful customers, the ultimate suppliers might have cancel/ stop the supplies to our audit client.

As such, working capital need to be analyzed by auditor to identify unusual circumstances that might occur.

#68 Evaluation of Doubtful Debt

Subsequent to the topic of #67 Identification of Doubtul Debt, we would like to proceed further on how to evaluate the exposure to doubtful debt. A very critical question to ask: Does all long outstanding debt represents doubtful debt, for which the provision need to be provided for ? The answer is very subjective, and involved a lot of professional judgement.

Let's start the evaluation with asking our readers a few scenarios as below:

[Scenario A] XYZ Company has outstanding amout due from Company A (aged > 90 days), who is long standing customer of XYZ Company for the past 10 years with no history of default in repayment. The long outstanding amount is attributable to the slow-repaying from Company A.

[Scenario B]XYZ Company has outstanding amount due from Company B(aged > 90 days), who is long standing customer of XYZ COmpany for the past 20 years with no history of default in repayment. Company B usually paid the amounts on time. There is no dispute involved in the outstanding amount due from Company B.


We invite our 'Accouting & Auditing blog' readers to evaluate the recoverability of outstanding amount due from Company A and Company B respectively.

#67 Identification of Doubtful Debt

How do we identify potential doubtful client while performing audit ?

We have to identify the doubtul receivable before assessing the potential provision for doubtful debt for respective client. Be noted that, provision for doubtful debt should be assessed on a specified basis. General provision is no longer allowed in IAS 39. IAS 39 requires existence of objective evidence of impairment on doubtful receivable. General provision does not take into consideration of any evidence.

Let's come back to the topic on how do we identify slow moving debtors step-by-step:

1. Obtained trade debtor aging listing ( by customer) as at the balance sheet date
2. Pay attention to debtors who have outstanding debts overdue more than 60-90 days
( the number of days could be changed according to the industry norm)
3. Selected the debtors ( with significant outstanding long outstanding debts according to the audit materiality of the engagement

In short, we analyze the debtors who has: 1) long outstanding balance ( generally overdue more than 60- 90 days) and 2) the long outstanding balance is considered material for the purpose of audit.

#60 Implication of Internal Control- Impact of Credit Crunch on New Customers

In the current environment, where credit crunch impacts are prevailing, there are increasing credit risks of the Company. With the eagerness to obtain new customers, the strict credit risk assessments ( of new customers) should not be compromised.

The entity ( that are directly and severely affected by the credit crunch) should evaluate creditworthiness of new customers cautiously. Complete information needed to be obtained, for instance:
- Financial results of the Company
- Inquiries with market peers/ industrial person
- Shareholders' fund of the Company
- Reasons for purchasing from the entity

The entity can discuss with the new customer on the reason to purchase from them, as the supplies customer might have been discontinued from other supplies, due to credit risk concern.

Hence, a complete understanding and proper approval process need to be undertaken to prevent doubtful debt issue.

#59 Accounting treatment for bad debt provision

What would be the accounting entries while the collectibility receivable from a customer is deemed to be in doubt:

Dr. Bad Debt Expense (P/L)
Cr. Provision for Doubtful Debt (B/S)
Being provision for doubtful debt on receivable from XYZ

Provision for doubtful debt (B/S) relates to a contra account to Account Receivable. As such, the provision amount will be off-set against Account Receivable. Whereas, bad debt expense is generally classified as administrative expense in Profit & Loss statement.

#53- General Provision on Doubtful Debt

In some instances, general provision for doubtful debt is provided for accoridng to the age of the outstanding debt. However, General provision for doubtful receivable is no longer allowed subsequent to the implementation of IAS 39.

IAS 39 states that:

“A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated.”

As such, impairment loss should be recognized when, subsequent to the initial recognition of the receivable, an event has happened which causes the receivable to be impaired. General provision provided according to age of the outstanding is no longer allowed. A financial asset should be impaired if, and only if, there is objective evidence of impairment.

#27 Classification of Bad Debt Expense

Should the bad debt expense be net off from the gross profit? or should it be classified in other operating expense?

The answer is: bad debt expense should be classified as General & Administrative Expense in Profit & Loss.

#2 Accounting Treatment for Bad Debt Recovered

Assuming a manufacturer, XYZ Ltd who has a number of regular customers ( debtors), who purchased on credit term. However, one of the customer, said ABC Co. has long outstanding debt due to XYZ Ltd. The outstanding position is significantly longer than industry average. Hence, the XYZ Ltd would make a provision of doubtful debt for the amount due for the outstanding debt due from ABC Co.:

Dr. Bad Debt Expense XXX
Cr. Provision for Doubtful Debt XXX

Due to unexpected cash in-flow to ABC Co, and ABC Co. pay off the debt due to XYZ Ltd; hence, in XYZ accounting book, they would reverse the provision made:

Dr. Provision for Doubtful Debt XXX
Cr. Bad Debt Recovered (P&L) XXX