What are General Provisions
General provisions are balance sheet items representing funds set aside by a company as assets to pay for anticipated future losses. For banks, a general provision is considered to be supplementary capital under the first Basel Accord. General provisions on the balance sheets of financial firms are considered to be a higher risk asset, because it is implicitly assumed that the underlying funds will be in default in the future.
BREAKING DOWN General Provisions
Account names for general provisions either vary with the type of account or may be listed as a consolidated figure in parentheses next to accounts receivable (AR).
General Provisions for Companies
A company that records transactions and works with customers through AR may show a general provision on the balance sheet for bad debts or for doubtful accounts. The amount is uncertain, since the default has not yet occurred, but is estimated with reasonable accuracy based on company history. For example, the company may analyze write-offs from the prior accounting year when establishing general provisions for doubtful accounts in the current year. When a write-off is used for clearing a specific account, the amount is transferred to bad debt expenses.
Companies providing pension plans may set aside a portion of business capital for meeting future obligations. If recorded on the balance sheet, general provisions for estimated future liability amounts may be reported only as footnotes on the balance sheet.
General Provisions for Financial Institutions
Because of international standards, banks and other lending institutions are required to carry enough capital to offset risks. The standard may be met by indicating on the balance sheet either an allowance for bad debts or a general provision. The reserve funds provide backup capital for risky loans that may default.
A specific provision is created for receivables facing serious financial problems or for a trade dispute with the entity. The balances may be noted by examining an aged receivable analysis detailing the time elapsed since creating the document. Long-outstanding balances may be included in the specific provision for doubtful debts. However, a specific provision may not be created for the entire amount of the doubtful receivable. For example, if there is a 50 percent chance of recovering a doubtful debt for a certain receivable, a specific provision of 50 percent may be required.
Changes in Financial Reporting Standards
The act of creating general provisions has been declining since revisions in International Financial Reporting Standards (IFRS). International Accounting Standards (IAS) 39 prohibits creating general provisions based on past experience, due to the subjectivity involved in creating the estimates. The reporting entity is required to carry out impairment review for determining the recoverability of the receivables and any associated provisions.