What is Provisioning? Risk, Bad Debt, and Doubtful Debt Reserve Funds

Vu Khoi

Author at Wotech Electronics Blog

Provisioning plays an important role in helping a business assess its operating situation and set aside reserves for losses arising from asset value write-downs and bad debts. Provisioning must be carried out in accordance with the circulars and regulations of the Ministry of Finance and the State Bank of Vietnam. Businesses need to clearly understand the principles of bad debt provisioning as well as provisioning for other asset types in order to avoid errors in practice.

What is provisioning?

Provisioning means establishing a reserve used to cover the difference in a company's asset values between the time of financial reporting and the time of purchase, or a reserve corresponding to bad debts and payables. A business must carry out provisioning specifically for each group of items so that it can make accurate assessments of its business performance and take the necessary steps to recover debt.

Inventory provisioning

What is inventory provisioning?

Inventory provisioning means setting aside a reserve for the portion where the real value of inventory may fall below its book value. The objects of provisioning are therefore goods, supplies, and tools owned by the company at the time of reporting whose original book value is higher than their current value, and which are supported by documentation of the cost at which they entered the warehouse.

The inventory provision rate

The provision amount is determined by taking the quantity of inventory at the time of reporting, multiplying it by the original cost recorded in the books, and then subtracting the net realizable value of the goods. The original cost of inventory must be determined in accordance with Vietnamese Accounting Standard 02 on Inventory issued by the Ministry of Finance. The net realizable value of the goods is decided by the business itself, calculated as the estimated selling price of the inventory in the production period minus the costs required to sell the goods.

Provisioning for financial investments

What is provisioning for financial investments?

Investment provisioning means setting aside a reserve for potential losses when a company's securities or other investment funds decline in value.

The provision rate for financial investments

For securities investments, the provision amount is calculated as follows:

Booked value of the securities investment – (quantity of securities the company holds at the time of reporting x the actual market value of the securities).

For listed securities, the actual value is calculated based on the closing price on the last trading day. For stocks registered for trading but not yet listed, the actual value equals the average of the reference prices over the most recent 30 days.

For other investments, the provision amount is calculated by taking the company's actual ownership percentage of charter capital at the capital-receiving organization, multiplying it by the owners' actual invested capital in that organization, and then subtracting the owner's equity of the capital-receiving entity. Here, the owners' actual invested capital and the owner's equity of the receiving organization are determined from the balance sheet of the capital-receiving entity.

Bank provisioning

What is bank provisioning? This is perhaps a question many readers find puzzling, because banking encompasses many different activities and categories. In essence, bank provisioning means setting aside reserves for bad debts or risks that the bank may encounter through its financial activities. Provisioning for bad debts helps the bank limit risk and evaluate customer files.

Distinguishing debt groups

Before diving into provision rates and conditions, anyone working in receivables accounting needs to understand the debt classification rules. This helps the bank when carrying out provisioning for the various debt groups. Under Regulation 18 issued in 2007 by the State Bank of Vietnam, debts are divided into 5 groups as follows:

• Group 1 (Current debt) includes debts that can be recovered in full — both principal and interest — on time

• Group 2 (Special mention debt) includes debts overdue by 10 to 90 days, where the customers are individuals or businesses still fully capable of repaying

• Group 3 (Substandard debt) includes debts overdue by 91 to 180 days, and debts whose interest has been reduced or waived because the customer cannot pay interest as required

• Group 4 (Doubtful debt) includes debts overdue by 181 to 360 days

• Group 5 (Likely loss debt) includes debts overdue by more than 360 days

What is risk provisioning?

Risk provisioning, also known as credit risk provisioning, is a reserve for losses arising from bad debts (debts in groups 2, 3, 4, and 5). Under credit risk provisioning Regulation 493, the provision rates for the 5 debt groups are as follows:

• Group 1: 0%

• Group 2: 5%

• Group 3: 20%

• Group 4: 50%

• Group 5: 100%

Under the bad debt provisioning rules, the specific provision amount is calculated using the following formula: R = max {0, (A – C)} x r

Where: R is the provision amount that must be set aside

A is the outstanding principal balance of the debt

C is the deduction value of the collateral

r is the provision rate

What is provisioning for doubtful receivables?

Provisioning for doubtful receivables is a loss reserve for receivables that are past their payment due date, or receivables not yet due but unlikely to be recovered. A debt is considered unlikely to be recovered when the debtor organization has fallen into bankruptcy, is undergoing dissolution procedures, or is being prosecuted, detained, or put on trial.

For overdue receivables, the business must provide complete documentation proving the amount the debtor has not yet paid, such as a loan agreement, a debt commitment letter, a contract settlement record, or a statement of receivables. Provisioning for overdue debt is regulated as follows:

• 30% of the value for debts of 6 months to under 1 year

• 50% of the value for debts of 1 year to under 2 years

• 70% of the value for debts of 2 years to under 3 years

• 100% of the value for debts over 3 years

For doubtful receivables, the business draws on its doubtful debt reserve to cover the loss; any shortfall is booked as a business expense. Once a write-off decision is made under the rules above, the business must keep it updated in its financial statements for at least 10 years in order to continue tracking it and pursuing debt recovery measures.

Provisioning for severance allowances

Provisioning for severance allowances is a reserve fund used to pay allowances to workers who resign from or lose their jobs at the company. The specific provision rate ranges from 1% to 3% of the company's social insurance salary fund. Any portion of the reserve not spent during the year is carried over as a balance into the following year.

Conclusion

This article has presented the regulations and conditions for provisioning. In essence, provisioning is broken down into smaller tasks such as provisioning for payables, inventory, financial investments, banking, and severance allowances. Businesses need to understand the requirements of each type and carry them out in full compliance with the regulations.

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