What is a Bad Debt Provision?
A bad debt provision is made where there is some reasonable expectation that a trade debtor(s) may not pay their debt, either in part of full.
A bad debt provision allows the full amount of the invoice sent to the customer to remain on the trade debtors control account since no formal agreement has been made in regards to how much of it will be paid – no credit note has been raised and the VAT element is unaffected. The bad debt provision is reported on the balance sheet, reducing the overall amount of trade debtor owed to the business.
An Example of the Bad Debt Provision
As at 31 January 2018, a customer has been invoiced £8,000 plus VAT, total £9,600. It is considered doubtful that the full amount of the invoice will be paid and it is noted that 50% of the debt is likely to be paid, that is £4,000.
A provision for bad debt is therefore considered necessary in the accounts of £4,000.
Journal Entry for Bad Debt Provision
The journal entry in the above example would therefore be:
Dr Bad Debts (profit & loss account) £4,000
Cr Bad Debt Provision (balance sheet) £4,000
Once certainty is found regarding the settlement of the debt the necessary credit notes raised, the bad debt provision should be reversed.