Provision - What is a provision?
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An amount from profits that has been put aside in a company's accounts to cover a future liability is called a provision.
The main purpose of a provision is to adjust the current year balance to become more accurate. This is because there may be costs that could be accounted for in either the previous financial year, or the current financial year.
Costs that belong to a certain year can become misleading if accounted for in previous or future accounting years, depending on the circumstances.
A few facts about provisions
A provision is in fact not a form of savings, though it may appear so at first glance.
In accounting, provisions are recognised on the balance sheet and also expensed on the income statement. The resulting impact of a provision is a reduction in the company's equity.
Setting aside a provision
There are a number of factors that could cause a company to create provisions, however there are certain criterions that must be fulfilled before a financial obligation can be viewed as a provision, such as:
- The company must perform a reliable amount of regulatory measurement of that obligation. The measurement must be made by company management.
- It must be probable that the obligation results in a financial drag on economic resources.
- An obligation must be a result of events that will advance the balance sheet date, and could result in a legal or constructive obligation.
- An obligation must be determined to be probable, but not certain. It must be estimated to have a more than 50% probability of occurring.
What can be considerd a provision?
Common provisions are:
Provision for bad debts
A provision for bad debts is one that has been calculated to cover the debts encountered during an accounting period that are not expected to be paid.
This provision is usually included in the budget created by a company and can be estimated based on past experience with bad debt amounts as well as industry averages.
Tax and provisions
A general provision is not allowed as a deduction for tax purposes.
A specific provision, in which specific debts are identified, is allowed as a tax deduction if there is documentary evidence to indicate that these debts are unlikely to be paid.
Provisions and Debitoor
Managing your cashflow in Debitoor is simple and highly automated. It is designed specifically for the sole trader or small business owner, but is also able to grow with a company as it needs increasingly more features such as financial reports.
While provisions generally aren’t necessary for freelancers or companies just starting out, Debitoor offers a ‘bad debt’ category for expenses, where you can record lost income. On one of our larger plans you can also enter and track depreciation of assets.