Bookkeeping and accounting use the term provision meaning an estimated amount set aside when it is probable that a liability has been incurred or an asset impaired. It is a contingent loss that is recognized as a liability.
There are many reasons why a business would want to create a provision in its accounting records, the list below shows some of the reasons why provisions might be established.
- Provision for depreciation
- Impairment provision for the diminution in the value of assets
- Provision for repairs and renewals
- Provision for bad debt and doubtful debts
- Provision for warranty costs
In each example the business knows that it is probable that a liability has been incurred, and although it cannot determine the exact amount of the liability, it can be estimated with a reasonable degree of certainty.
Provision Definition in Bookkeeping
Provisions are established by recording an appropriate expense in the income statement of the business and establishing a corresponding liability as a provision account in the balance sheet statement.
The journal to record the provision would be as follows.
| Account | Debit | Credit |
|---|---|---|
| Expense | XXX | |
| Provision account | XXX | |
| Total | XXX | XXX |
The provision account is included in the liabilities section of the balance sheet either as a current or non-current liability depending on its exact nature.
Provision Accounting Example
Warranty costs are a good example of a provision. Based on historical or industry data a business can estimate the expected number of warranty claims and the average cost of each claim. The cost is both probable and can be estimated and therefore should be provided for.
Suppose a business has estimated warranty costs for the year of 6,000, then the following journal would be included in the accounting records.
| Account | Debit | Credit |
|---|---|---|
| Warranty expense | 6,000 | |
| Provision for warranty costs | 6,000 | |
| Total | 6,000 | 6,000 |
Further details of the treatment of warranty costs can be found in our warranty costs tutorial.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.