Most larger organisations understand that businesses will almost certainly at some time, not be able to collect all outstanding accounts. Companies can be placed into Receivership or Liquidation and individuals can declare bankruptcy. Others can simply refuse to pay.

For this reason, it makes sense to have a contingency for any doubtful debts on your monthly ledger. It doesn’t matter what the reason may be for non-payment, but it’s a good method of accounting for the expense of non-collection over a given period.

There are several methods in which to calculate the provision:

• % of Sales
  Calculated on sales made on credit, with a pre-determined percentage.
  Eg: 2% of sales made on credit is decided as being possibly uncollectable. Sales on credit for the month totals $250,000.00, so the bad debt provision would be $5000.00.
• Total Accounts Receivable
  Similar to above but the calculation is based on all accounts receivable.

  Eg: $430000.00 is the total receivable balance for the month, and it is decided that 2% is likely to be uncollectable, the bad debt provision would be $8600.00.

• Accounts Receivable Aging
  For this calculation, it is accepted that the older the credit sale (debt) the less likely the account will be paid. Usually a business with older accounts outstanding, is more likely to incur bad debt. Accounts are sorted into aging detail and calculated with the pre-determined percentage. It may look something like this:

The provision allows for businesses to recognise bad debt as soon as possible (unless you rely on the Aging method) This will then allow business to identify bad debts in each reporting period.

Provision calculations are estimates only as no-one can pre-determine how much isn’t likely to be paid.