Accounting and auditing for bad debt provisions

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Companies often believe that this is an easy calculation…just apply 10% against our debtor balance.  Now this may work as an approximation for your management accounts but it won’t do for your annual financial statements.  Below is a description of the method that ought to be adopted under FRS102: The starting point is to ensure that your trade debtor balances are being held at fair value.  This is usually the original invoiced amount.  If the trade debt was subject to any long-term arrangement then there may be a need to discount it, but this is rare. To the extent that you have stopped seeking to collect the debt, you should write it out the books entirely. Whilst you still have in mind that it is collectable you should consider impairment or providing against it. Where you can, a general provision is not likely to give an accurate outcome and will be taxed inefficiently. So, you should be looking to measure the provision on a specific basis.  Note that general provisions are disallowable for corporation tax whilst specific provisions are allowable. You should be reviewing each balance and assessing what the probable amount you anticipate receiving will be, and to provide against the difference.  When reviewing the individual balances, you should bear in mind historic experience and any risk characteristics you may be aware of. Some companies have thousands of customers and assessing each individual balance may not be possible.  In this case you may consider grouping customers and applying a similar treatment to each group.  You are however, strongly advised to discuss this treatment with your tax advisers to ensure that this may not be seen as general provisioning. You should be applying this provisioning method to non-trade loans as well. Ie loans with connected parties.  It is worth noting that the tax treatment on provisioning on some connected party loans may be disallowed regardless if they are specific or general. It is worth understanding what an auditor will be looking for to assess if the bad debt provisioning is true and fair.  The auditors will be applying the benefit of hindsight.  So, if the audit occurs 7 months after the year end then the auditor will want to look at the position of those debts that existed at year end and 7 months later to establish if the probability of collection has got better or worse.  Particularly the auditor would want to look at after date cash and any correspondence to assess this probability of collection. Also remember that you can only claim the VAT back on the bad debt once it is written off and so by unnecessarily holding the debt and providing it in your books may hurt your cashflow.  VAT bad debt relief can only be claimed on debt between 6 months and 4 years old. Every company and every industry is different and the application of bad debt provisioning is not always straightforward.  In any case you are advised to discuss what you are doing with your accountants.

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