Under Provision

Under provision happens when our estimated provision is less than the actual expense. Provision is the amount that the accountant has estimated to cover the expected future expense or decrease of asset value. We need to estimate it and account in the current financial statement rather than wait until it happens and 100% impact the future accounting record.

For example, the provision includes accrual asset impairment, bad debt expense, warranty claim, inventory obsolete, and so on. Provision expense is the allocation of probable but not certain about future obligations. We just estimate the amount of expense that could be happening or not, for example, the bad debt may or may not incur. At the same time, the provision also decreases the asset balance to prevent it from overstate. For example, the provision of bad debt also reduces the net amount of accounts receivable.

Provision Journal Entries

When we provide provision over bad debt expense, we will record bad debt expense in the income statement and credit accounts receivable in the balance sheet. The recorded amount depends on management estimation.

Account Debit Credit
Bad Debt Expense $$$
Provision for Bad Debt $$$

Provision for bad debt is the contra account of accounts receivable and it will impact the net balance of AR show in balance sheet. It is similar to accumulated depreciation in the fixed asset section.

When actual AR is uncollectable, we simply deduct the provision balance and accounts receivable as following:

Account Debit Credit
Provision for Bad Debt $$$
Accounts Receivable $$$

The transaction will not impact the income statement as well as the net balance of Accounts receivable in the balance sheet. If the actual bad debt is higher than our provision, it means that we are under-provision, so the difference will impact the income statement.

Account Debit Credit
Bad Debt Expense $$$
Provision for Bad Debt $$$
Accounts Receivable $$$

Example

On 31 Dec 202X, Company has accounts receivable balance of $ 1,000,000. Based on historical data, management estimate that 2% of accounts receivable is uncollectable. They provide provision base on this estimation.

On 31 Dec 202X+1, the actual bad debt is 30,000 due to an economic downturn. The company decided to write off this balance as it is clear that the customers will not be able to pay.

Journal Entries

  1. On 31 Dec 202X, we have to make provision in order to recognize bad debt expense.
Account Debit Credit
Bad Debt Expense 20,000
Provision for Bad Debt 20,000

After provision, the net accounts receivable balance in the balance sheet will decrease to $ 980,000.

  1. On 31 Dec 202X+1, we have the actual information. The uncollectable amount is $ 30,000 which is $ 10,000 more than our estimate. So we have to record the additional expense in our income statement.
Account Debit Credit
Provision for Bad Debit 20,000
Bad Debit Expense 10,000
Accounts Receivable 30,000

After the adjustment, we have write off Accounts Receivable, Provision, and record total bad debt expense of $ 30,000 (20,000 in 202X and 10,000 in 202x+1).

Over Provision

On the other hand, our provision may be higher than the actual result. So the accounts receivable we have to write off is less than the provision. The difference needs to record in the income statement (bad debt expense) but on the credit side. It means the expense needs to reduce in the new accounting period when we write off the actual uncollectable accounts receivable.