Provision for bad debt is the current assets account in the balance sheet that uses to records the provision for bad debt that the entity provides to account receivables that collection likelihood is high.
This account is similar to accumulate depreciation that use to records the accumulation of depreciation to show the carrying value of fixed assets. Provision for bad debt is also known as provision for doubtful debts or allowance for doubtful debt.
The increase of provision for bad debt means makes net accounts receivable decrease. This account is used to calculate the net realizable value of accounts receivable after provision. In other words, it is the collectible amount of accounts receivable.
What are accounts receivable?
Accounts receivable are happened when the company provides the goods or services to customers, billed them but the customers are not making the payments to those invoices. In this case, the accountant needs to records these transactions as accounts receivable.
For example, if the company sells goods amount USD 2k to customers on credit and accountant also passes the invoices to customers. In this case, the accountant should records sales amount USD 2K on credit and records USD 2K on debit in accounts receivable.
Accounts receivable are the current assets account where increasing of them are recording in debit and decreasing of them are recording in credit. They are the collectible amount from customers.
What is provision for bad debt?
However, in the real world, not all of the customers that company sales goods or renders services are making payments. Some good customers make payments on time and the bad one does not only process payment late but also ignores the payments. In this case, the business might try to negotiate or take some legal action.
This what happens in the business and from an accounting perspective, if there are long outstanding accounts receivables happen, an accountant needs to review the possibility of collection.
If the likelihood of collection is not good then the provision needs to apply to certain accounts receivable that at the of the period there is only the net of account receivable are presented in the balance sheet.
Sometime, to make it easy for the accountant, the company might set up an accounting policy for this provision. For example, the provision will be 100% for outstanding longer than 120 days and 50% for long outstanding longer than 90 Days.
Let say the provision here is USD 30K and the accounts receivable before provision is USD 300K. That means the USD300K is the gross value of accounts receivable and the value that they expected to receive should be less than that amount by USD30K.