Definition of Provision in Accounting

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A firm records loss provisions when it is unable to recover amounts from customers or borrowers.
A firm records loss provisions when it is unable to recover amounts from customers or borrowers. (Image: debt defined image by Christopher Walker from Fotolia.com)

Accounting rules require a company to review its operating data periodically and ensure that loans and customer receivable amounts are accurate. These rules include generally accepted accounting principles and international financial reporting standards.

Definition

In accounting parlance, a provision is an estimation that senior management makes in anticipation of a customer's default on a loan or account receivable.

Significance

Recording loss provisions is important because it helps department heads manage credit risk appropriately in operating activities. Credit risk is the loss expectation resulting from a business partner's inability to pay a loan when due.

Bad Debt

Bad debt is customer receivables that are noncollectable. To record a bad debt provision, an accountant debits the bad debt expense and credits the allowance for doubtful items account.

Loan Loss

A company records loan loss provisions similar to bad debt. To record a loan loss provision, an accountant debits the loss provision account and credits the note receivable account.

Provision Reporting

Generally accepted accounting principles and international financial reporting standards require a company to report the allowance for doubtful items in the balance sheet and bad debt in the statement of profit and loss.

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