What Is the Provision for Credit Losses?

A bank must records provisions for loan losses if a customer defaults.

A financial institution, such as a bank or insurance company, records a loss provision if senior management believes they may not recover funds from certain customers because of those customers' ongoing credit challenges. Regulatory guidelines also require that a firm reports credit loss provisions in its financial statements.

Definition and Importance

A provision for credit loss is an expense that a bank sets aside as an allowance for bad loans, according to Investopedia. A credit loss provision allows the bank to measure the value of current loans and estimate likely defaults. A credit loss results from a customer's inability to repay a loan, because of bankruptcy or other financial difficulties. Credit loss evaluation helps a firm monitor and improve its credit policies.

Accounting for Credit Loss Provision

To record a credit loss provision, an accountant debits the bad debt expense account and credits the allowance for doubtful items account. The allowance for doubtful items account is often referred to as the credit loss provision account.

Reporting Loss Provision

At the end of each quarter or month, an accountant reports the provision for credit losses in the balance sheet. The bad debt expense account is an income statement item.

References

• Venture Line: Provision for Credit Losses
• U.S. Department of Treasury: Allowance for Loan and Lease Losses
• Investopedia: Loan Loss Provision
• Investopedia: Allowance For Bad Debt