The entity creates provision for doubtful and disputed receivables where there is a risk that they will not be paid or where the debtor has entered the insolvency procedure. The provision represents an indirect reduction in the value of the receivable. It is recorded on the debit side of expense account 558 (if it is a statutory, i.e., tax-deductible allowance) or 559 (if it is a purely accounting allowance) and on the credit side of account 391. Should it be shown that the further existence of the provisions is not justifiable in the following accounting period (based on the inventory), the provisions are released by a reverse entry in the expense accounts (558, 559).
Statutory provisions affect the income tax base and are regulated by the Act on Reserves. Other provisions, also known as accounting provisions, affect only the accounting profit or loss and are regulated by the entity's internal directive and thus, shall follow general accounting principles. It is important to mention that in the case of provisions, the impairment (decrease in value) must be of a temporary nature, rather than a permanent impairment.
When receivables are loss-making or uncollectible, the entity has the option to write them off. The write-off represents a permanent reduction of the receivable’s value, directly to the credit side of the account of receivables and to the expense side of account 546. Receivables may be written off gradually or at once. The Income Tax Act specifies when account 546 is an accounting expense only and when it will also affect the income tax base. If the written-off receivable is settled, the entity would incur income in account 646. Written-off receivables are then generally further recorded in off-balance sheet accounts.
In practice, it is not uncommon for a specific receivable to be subject to both a statutory provisions (up to the amount allowed by the Act on Reserves) and an accounting provision(up to the amount that actually reflects the level of risk associated with non-payment of the receivable). If a statutory provision is already created for the receivable, then the most appropriate way to record an accounting provision is to record only the difference between the estimate of the actual impairment of the receivable and the amount of statutory provision.
The most common error made by accounting entities is to limit the creation of provisions to only statutory provisions. Considering the strict conditions for selection of receivables for which statutory provisions may be created, it results in the situation when those receivables which may not be subject to the statutory provisions remain untreated from the point of view of accounting rules, even if the accounting provisions would be appropriate.
Finally, it should be emphasised that a necessary condition for the correct creation and recording of provisions is carefully elaborated principles for the creation and use of provisions in an entity and their continuous compliance.
In the absence of a detailed inventory of receivables and provisions, it may happen that provisions for receivables already paid are not reversed or untreated bad debts may remain in the accounting books.
Should you need advice on how to correctly create provisions for receivables, please do not hesitate to contact our Crowe team.
Contact our expert