PCL: Definition, Application, and Example (Loan Loss Provision for Beginners)

 A company's potential losses owing to credit risk are estimated in the provision for credit losses (PCL). On the company's financial accounts, the provision for credit losses is represented as a cost. They are predicted losses resulting from overdue and bad debt, as well as other credit that is likely to fail or become unrecoverable. The firm will make a provision for credit losses based on 40% of the balance of these accounts, for instance, if it determines that accounts that are more than 90 days past due have a 40% recovery rate.

PCL: Definition, Application, and Example (Loan Loss Provision for Beginners)

Accounts receivable (AR) is represented as a current asset on a company's balance sheet since it is expected to be converted to cash within a year or an operational cycle. However, because accounts receivable may be exaggerated if a part is not collected, so may the company's working capital and stockholders' equity.

A company may estimate how much of its accounts receivable will most likely not be collected in order to avoid overstating the case. The estimate is recorded in the provision for credit losses balance sheet contra asset account. Increases to the account are also recognized as uncollectible accounts expenditure on the income statement.

An Illustration Of A Credit Loss Provision

On June 30, Company A's AR has a $100,000 negative balance. Approximately $2,000 is not likely to be converted to cash. As a result, a $2,000 credit amount is recorded as a provision for credit losses. The income statement account uncollectible accounts expenditure is included in the accounting entry for modifying the amount in the allowance account.

Company A started its operations in June, so its provision for credit losses account had no balance at the start of the month. When it produces its first balance sheet and income statement on June 30, it will have a credit amount of $2,000 in its provision for credit losses.

• The balance sheet shows a net sum of $98,000 since the provision for credit losses has a credit balance of $2,000 and AR has a debit balance of $100,000. Because the net amount is likely to be converted into cash, it is referred to as the AR's net realizable value.

On its June revenue statement, Company A shows credit losses of $2,000 for uncollectible accounts. Despite the fact that none of the AR was due in June, the expenditure is reported since terms are net 30 days. Company A is striving to adhere to the matching principle by allocating bad debts expenditure to the accounting period in which credit sales happened.