Provision for Doubtful Debts: Estimating and Booking It
- Why it matters
- Step 1: Build the ageing schedule
- Step 2: Apply a rate to each band
- Step 3: Adjust for specific customers
- Step 4: Book only the change
- Writing off a debt
- When a written-off debt is recovered
- How often to review
- What reviewers and auditors ask
- Where this fits
A provision for doubtful debts is an estimate of how much of the money customers owe you will never be collected. It is recorded as an expense in the period the sales were made and shown as a reduction from receivables in the balance sheet, so that profit and assets are not overstated by invoices that will not turn into cash. The most practical way for a small business to estimate it is an ageing analysis: the older an invoice, the higher the percentage provided against it.
A provision is not a write-off. The customer still owes the money, and you keep trying to collect it. The provision simply stops the accounts pretending that every rupee will arrive.
Why it matters
Without a provision, a business that has ₹20 lakh of receivables, some of them a year old from customers who have stopped responding, reports all ₹20 lakh as an asset. Profit looks healthier than it is, and a lender reading the balance sheet sees working capital that does not exist. When the losses are finally written off, they land in a later year and distort that year’s results instead.
Step 1: Build the ageing schedule
Group every open invoice by how long it is past its invoice date or due date. Use one basis consistently.
Step 2: Apply a rate to each band
Set rates from your own history where you can: of invoices that reached 90 days overdue in past years, what share was eventually never collected? Where history is thin, use cautious judgement and refine it each year.
| Age band | Receivables | Provision rate | Provision |
|---|---|---|---|
| Not yet due to 30 days | ₹12,00,000 | 1% | ₹12,000 |
| 31 to 90 days | ₹5,00,000 | 5% | ₹25,000 |
| 91 to 180 days | ₹2,00,000 | 20% | ₹40,000 |
| Over 180 days | ₹1,00,000 | 50% | ₹50,000 |
| Total | ₹20,00,000 | ₹1,27,000 |
Illustrative rates. The right rates depend on your customers, industry and collection history.
Step 3: Adjust for specific customers
An ageing matrix is a starting point, not a substitute for knowledge. Override it where you know more:
- A customer that has gone into insolvency or closed down: provide for the full balance, whatever its age.
- A disputed invoice where you expect to issue a credit note: deal with it as a sales adjustment rather than a bad debt.
- An old balance from a government department or large company that pays slowly but reliably: a lower rate may be justified, with a note explaining why.
- Balances backed by a security deposit or guarantee: provide only for the unsecured part.
Step 4: Book only the change
The provision account carries its balance from one period to the next. You record the difference between the required provision and the existing balance.
If the provision already stands at ₹90,000 and the schedule now requires ₹1,27,000, the entry is for the increase of ₹37,000:
| Account | Debit | Credit |
|---|---|---|
| Bad and doubtful debts expense | ₹37,000 | |
| Provision for doubtful debts | ₹37,000 |
If the required figure falls below the existing balance, because old invoices were collected, reverse the excess with the opposite entry.
In the balance sheet, receivables are shown at ₹20,00,000 less the provision of ₹1,27,000, a net ₹18,73,000.
Writing off a debt
When a debt is finally judged uncollectable, for example after the customer’s business has closed and recovery efforts have ended, remove it from receivables against the provision already made:
| Account | Debit | Credit |
|---|---|---|
| Provision for doubtful debts | ₹60,000 | |
| Customer account (receivables) | ₹60,000 |
This entry does not touch profit, because the expense was recognised when the provision was made. It then reduces the provision balance, which is rebuilt at the next review if needed.
When a written-off debt is recovered
If the customer later pays some or all of a debt you wrote off, reinstate the receivable and record the receipt, or record the amount directly as a recovery of bad debts in income. Either way, keep a note linking the receipt to the original write-off so the history is traceable.
How often to review
At a minimum, review the provision at each year-end. Monthly or quarterly reviews are better for businesses with significant credit sales, because they spread the expense across the periods it relates to and bring collection problems to management’s attention earlier.
What reviewers and auditors ask
- How were the rates set, and are they supported by past collection experience?
- Were large overdue balances considered individually?
- Have balances after the year-end been collected, which supports a lower provision, or not, which may call for a higher one?
- Is the method applied consistently from year to year?
Companies reporting under Ind AS apply an expected credit loss approach to trade receivables, which often uses a provision matrix built on similar principles. Confirm with your accountant which framework applies to your business and how it affects the method. This guide covers the accounting estimate only; whether and when a provision or write-off is deductible for tax is a separate question.
Where this fits
- Collecting before it comes to this: customer not paying: what to do
- The adjustments that sit beside it at month-end: prepaid and accrued expenses
- How it shows in the statements: trial balance to balance sheet
- When one customer is too large a share: customer concentration risk