Provision Expense Definition

A lender records a loan provision when a borrower experiences financial distress.

A financial institution, such as a bank, hedge fund or insurance firm, records a provision expense in accounting ledgers when the institution believes it may not recover loan amounts from a borrower.

Definitions

A debt is a loan that a borrower must repay. If a borrower files for bankruptcy or experiences other forms of financial distress, a lender may reduce the loan value in accounting books to reflect the probability of loss. Reducing a loan value is the same as recording a provision expense.

Significance

Recording a provision expense is important because it allows a bank to report accurate asset values in financial reports. A loan represents an asset to a lender. Incorrect loan values affect working capital calculations. Working capital indicates a company's short-term cash levels and equals current assets minus current debt.

Accounting and Reporting

To record a provision expense, an accountant debits the provision expense account and credits the loan receivable account. Provision expense often is called bad debt or doubtful accounts expense. The accountant reports provision expenses in the statement of profit and loss, otherwise known as the statement of income.

References

• Investopedia: Loan Loss Provision
• Investopedia: Allowance for Bad Debt
• Investopedia: How Do Banks Determine Risk?