What Are General Provisions?

What Are General Provisions?

Let me explain general provisions directly: these are items on a company's balance sheet that represent funds you've set aside as assets to cover anticipated future losses. If you're in banking, under the first Basel Accord, a general provision counts as supplementary capital. Keep in mind, on the balance sheets of financial firms, these are seen as higher-risk assets because it's assumed the underlying funds will default eventually.

Key Takeaways

You need to know that general provisions are those balance sheet items where funds are reserved as assets for expected future losses. The amounts you set aside come from estimates of what those losses might be. If you're a lender, you're required to establish general provisions with every loan to handle potential borrower defaults. Remember, creating these provisions has been on the decline since regulators banned basing estimates on past experiences.

Understanding General Provisions

In the business world, you can't avoid future losses—think falling asset values, defective products, lawsuits, or customers who can't pay up. To handle these, companies like yours must set aside enough money. But you can't just create a provision whenever you feel like it; you have to follow regulator criteria. Both GAAP and IFRS lay out the rules for contingencies and provisions. You'll find GAAP details in ASC 410, 420, and 450, while IFRS covers it in IAS 37.

Recording General Provisions

When you record a general provision, you enter an expense on the income statement and create a matching liability on the balance sheet. The account names can vary by type or appear consolidated in parentheses next to accounts receivable—that's the money owed for goods or services not yet paid. If your company deals with accounts receivable, you might list a general provision for bad debts or doubtful accounts. The amount is uncertain since no default has happened yet, but you estimate it reasonably.

In the past, you could base general provisions for doubtful accounts on write-offs from the previous year. But IAS 39 now forbids that due to the subjectivity in estimates. Instead, you must perform an impairment review to assess receivable recoverability and determine provisions. For pension plans, companies set aside capital for future obligations, often noting general provisions as footnotes on the balance sheet if they're for estimated liabilities.

Banks and Lenders Requirements

International standards require banks and lenders to hold enough capital to offset risks, which you can meet by showing an allowance for bad debts or a general provision on the balance sheet. These reserves back up risky loans that might default.

General Provisions vs. Specific Provisions

Specific provisions, as the name implies, address identified future losses—like when a customer hits serious financial trouble or has a dispute with your entity. You might spot these in an aged receivable analysis, where long-outstanding balances go into the specific provision for doubtful debts. But you don't always provision the full amount; if there's a 50% recovery chance on a doubtful debt, you might set a 50% specific provision.

For banks, you allocate general provisions when approving a loan, while specific ones cover actual defaults.

Special Considerations

Provisions have sparked plenty of controversy. In the past, accountants used them to smooth profits—pumping them up in good years and cutting back in bad ones. Regulators have cracked down, with new rules against subjective estimates leading to fewer general provisions overall.