The portfolio provision It is an estimate of the potential losses of a company due to the risk assumed by the credit given to customers in product sales. Businesses often have a percentage of customers who will not pay their debts, so they use this data to anticipate them and protect themselves from the impact of those lost funds..
So, the portfolio provision is an expense that the company incurs when a customer does not pay their invoice. The expense is debited in the accounting records of the company in the account "bad debt expenses" and is credited in the account "portfolio provision".
The portfolio provision is treated as an expense in the company's financial statements, as losses are expected from bad debts and other non-performing loans that are likely to become defaults or have a very high probability of default..
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When accounting for portfolio provision, a company does not need to know specifically which customer will not pay. You also don't need to know the exact amount; you can use an approximate amount that is uncollectible.
For example, if the company calculates that accounts receivable with more than 90 days past due have a recovery rate of 40%, it can make a portfolio provision based on 40% of the balance of these accounts.
A company can use statistical models such as probability of default to determine its expected losses from bad debt. Statistical calculations can use historical data from the business as well as the industry in general.
This same process is used by banks to report bad debts of borrowers who default on their loan payments..
Almost all companies carry out credit transactions with each other. This means that a company does not have to pay cash when purchasing merchandise from another company..
Since, by definition, accounts receivable are expected to become cash in less than a year or within an operating cycle, they are recorded as a current asset on the company's balance sheet..
However, accounts receivable may be inflated if there is any portion of these that is uncollectible. As a result, the company's working capital and stockholders' equity could also be bulky..
To protect itself from such a bulge in these accounts and metrics, a business can calculate how much of its accounts receivable is likely not to be collected.
The portfolio provision is the accounting technique that allows companies to take into account an estimate of these losses in their financial statements in order to limit the growth of potential income.
Increases in the portfolio provision account of the balance sheet are also recorded in the bad debt expense account of the income statement..
On the company's balance sheet, the portfolio provision is subtracted from the owner's assets and equity. By making these records, the equal amounts between assets and the sum of capital and liabilities are kept..
The portfolio provision fulfills the function of smoothing the impact on the company's financial statements due to uncollectible invoices.
The two accepted methods of portfolio provision, to establish the corresponding deduction when determining the taxable base for income tax, are the individual method and the general method..
The application of these particular methods is based on Colombian tax legislation. Each country will have the corresponding legislation for its own handling of the methods.
Through this method, the portfolio provision is determined by applying up to a 33% deduction as a provision on the balance of those accounts receivable that are already past due for more than one year..
The provision is applied individually only to accounts with a maturity of more than one year. On the other hand, it is allowed to handle percentages less than 33%.
In this method, portfolio provisions are calculated for accounts in general, according to the time they have expired, with the following percentages:
- For accounts receivable that have a maturity between three months and six months: 5%.
- Accounts receivable that are past due more than six months and less than one year: 10%.
- For accounts receivable maturing more than one year: 15%.
As of June 30, Company A's has an accounts receivable balance of $ 100,000. It is expected that approximately $ 2,000 will not be converted into cash. As a result, a balance of $ 2000 is recorded in credit in the portfolio provision account.
The accounting entry to adjust the balance in the portfolio provision account implies recording it also in the account "expense for doubtful accounts" of the income statement.
Because June was the first month in the business of company A's, the portfolio provision account started this month with a zero balance.
As of June 30, when the first balance sheet and income statement are issued, your portfolio provision will have a credited balance of $ 2000.
Because the portfolio provision is reporting a credit balance of $ 2,000, and accounts receivable is reporting a debit balance of $ 100,000, then the balance reports a net amount of $ 98,000..
The company's “bad debt expense” account reports losses of $ 2000 in its June income statement. The expense is reported despite the fact that none of the accounts receivable was due in June, as the terms are net of 30 days.
A company has $ 40,000 in accounts receivable as of September 30. He estimates that 10% of his accounts receivable will not be collected and proceeds to record a credit entry.
10% x $ 40,000 = $ 4,000 in portfolio provision.
To adjust this balance, a debit entry is made in the bad debt expense for $ 4000. Although accounts receivable are not due in September, the company is required to report credit losses of $ 4,000 as bad debt expense on its income statement for the month..
If the accounts receivable are $ 40,000 and the portfolio provision is $ 4000, the net amount reported on the balance sheet will be $ 36,000.
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