A provision for expected losses gets understated because the easiest way to set this period's figure is to take last period's and nudge it, rather than re-building the estimate from the current underlying exposure — and a rolled-forward number carries forward every optimistic assumption baked into the prior estimate, so as the real risk worsens, the provision lags behind it by construction, not by accident.
The specific habits that drive the lag
- Fixed percentage rules applied regardless of ageing: a flat "2% of debtors" provision ignores that a specific receivable has aged well past its normal collection cycle this year.
- Case-by-case review limited to the largest balances: smaller receivables or claims that individually look immaterial accumulate into a material aggregate shortfall.
- Reliance on management's collection confidence rather than the actual ageing or dispute history of the balance in question.
- No re-assessment trigger: nothing in the process forces a fresh look when a customer's financial position or a specific dispute visibly deteriorates during the year.
- Provision reversed too readily on partial recovery, without reassessing whether the remaining balance is still realistically collectible.
A provision balance that looks remarkably stable year over year is not, by itself, evidence that the underlying risk has been stable — it's often the clearest sign the provision is being rolled forward rather than re-estimated. Stability in the number and stability in the risk are two different claims, and only one of them is being tested when the figure simply repeats.
What actually corrects the understatement
Closing the gap requires going back to the specific facts behind each significant exposure — the ageing, the dispute status, the counterparty's current financial position — rather than trusting a formula or a rolled-forward figure to have kept up. The understatement isn't usually a calculation error; it's a provision that was never recalculated against the thing it was supposed to measure.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Revenue, receivables & cut-offAuditing bad debts and the provision for doubtful debtsThe expected credit loss model at a practical level, how it compares to ageing-based provisioning, testing management's assumptions, and the write-off authorisation trail.
- Audit documentationInd AS 37: provisions, contingent liabilities and contingent assets — the three-way splitThree categories, three completely different treatments — recognise it, disclose it, or say nothing. Getting the category wrong is the whole misstatement.
- Inventory & stockThe obsolete stock nobody had provided forA product line discontinued eighteen months earlier was still carried at full cost. Nobody had looked at it since the last unit sold.
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