Auditing bad debts and the provision for doubtful debts

Auditing the bad debts provision means establishing which provisioning model the client actually applies — the forward-looking expected credit loss model required under Ind AS 109 for Ind AS entities, or an ageing-based percentage scale common under Indian GAAP — testing whether the model's inputs and assumptions are supportable against the client's actual collection history and current circumstances, and separately tracing any amount written off during the year to a documented authorisation. A provision that merely matches last year's percentages rolled forward, with no fresh look at the receivables, is the recurring failure mode worth testing for directly.

Which model applies

Ind AS 109 requires entities within its scope to measure impairment of trade receivables using an expected credit loss approach, which looks forward to credit losses expected over the life of the receivable rather than only recognising a loss once it has clearly occurred. For trade receivables, a simplified approach is commonly applied that measures lifetime expected credit losses from initial recognition, often operationalised through a provision matrix built on historical loss rates adjusted for current and forward-looking information. Entities applying Indian GAAP under AS typically continue with an incurred-loss approach, providing against specific debts once there is evidence they may not be recovered, frequently operationalised in practice through an ageing-based percentage scale.

The ECL model at a practical level

A provision matrix is the practical tool most mid-market Ind AS entities use to apply ECL to trade receivables without building a full credit-risk model. It groups receivables by ageing bucket and assigns a loss rate to each bucket, derived from the entity's own historical default experience, then adjusted for current conditions and reasonable forward-looking information such as an expected slowdown in a customer's industry.

1. 01Obtain the historical loss rates used to build each bucket's percentageAsk for the calculation, not just the resulting table. A provision matrix with no visible derivation, where the percentages have simply been carried forward from a prior year, has not actually applied the ECL methodology that period.
2. 02Check the historical period used is representativeA very short or unusually benign collection history will understate the loss rate; a period distorted by one large one-off default will overstate it for buckets that single customer does not represent.
3. 03Test the forward-looking adjustment, if any is claimedManagement may adjust historical rates upward for a customer concentration in a stressed sector. Where no such adjustment is made despite an obvious current condition, such as a major customer's own financial distress being public knowledge, that absence is itself worth raising.
4. 04Recompute the provision on the year-end ageingApply the stated rates to the actual year-end ageing schedule independently, rather than accepting the client's computed total, to catch both arithmetic slips and buckets that were quietly reclassified to a more favourable ageing band.

Ageing-based provisioning under Indian GAAP

Where an ageing scale is used under an incurred-loss approach, the audit question shifts from whether the model is theoretically correct to whether specific receivables that show evidence of impairment have actually been identified and provided for, since an incurred-loss approach does not permit a purely mechanical percentage to substitute for that identification.

• Confirm each ageing bucket's percentage against the client's own history of actual write-offs by bucket, not an arbitrary round number carried forward for several years unchanged
• Identify specific receivables with indicators of impairment — a dispute, a customer in liquidation, a bounced payment — regardless of which ageing bucket they fall into, and confirm each has a specific provision rather than relying on the general scale alone
• Check that receivables settled or substantially recovered after the year end, but before the audit, are not left sitting in an ageing bucket that overstates the provision needed
• Cross-check the provision against the confirmation and subsequent-receipts work done on the same balances, since a disputed or unconfirmed balance should usually also show up in the provisioning assessment

Testing management's assumptions

The write-off authorisation trail

A write-off removes a receivable from the books entirely, and is a different event from providing against it. It should carry its own documented authorisation trail, independent of whatever triggered the earlier provision.

• Written approval from the appropriate level of management or the board, consistent with the entity's own stated authority matrix
• The specific reason for the write-off: insolvency, a settled legal dispute, a time-barred claim, or a commercial decision to give up collection
• Evidence that collection efforts were actually made and were unsuccessful, where the reason given depends on that
• Confirmation that the amount was already provided for, rather than being written off directly against the current year's expense with no prior provision, which would misstate the current period if the loss event in substance occurred in an earlier year