CFM4114 - Accounting for loan relationships: lenders: accrual and writing down or writing off bad debt

Bad debts

The Companies Act 1985 requires a lender to state any loan held as a debt (and any other loan held as a current asset investment) at the lower of cost and net realisable value. FRS18 ‘Accounting policies’ and its predecessor SSAP2 ‘disclosure of accounting policies’ require companies to prepare accounts where prudence has been applied. Companies commonly do this by creating bad debt ‘provisions’, although strictly speaking the reduction in value is an adjustment to the carrying amount of a debt, rather than a provision. It does not therefore fall under the scope of the accounting standard FRS12 ‘Provisions, contingent liabilities and contingent assets’.

Write off

Where a lender has foregone all reasonable expectation of recovery, it will write off the loan completely, taking the loan out of its debtors, and expensing the item to bad debt expenses in the profit and loss account.

Write down

Where a lender expects to make a recovery, but is doubtful that it will

• recover the full amount of the debt, or
• make any recovery but is uncertain,

it will write down the carrying value of the debtor to the amount that it does see as recoverable, by creating a provision. It will charge the item to a bad and doubtful debt provision expense (this is often just a component of the total bad debt expense item). It will regularly reassess the amount of the recoverability of a loan, including taking account of any receipts, and make profit and loss account debits and credits accordingly.

Banks and insurance companies should follow the specific guidance included in the Statements of Recommended Practice for banks (Advances) and insurers (Accounting for insurance business).