Overheads - Provisions

Overheads that do not involve the transfer of cash out of the business are provisions. Depreciation is one example; a provision for bad debts another.

Common Provisions

Charges to profits for losses that are anticipated but not yet incurred define provisions. Because no cash transfers will have been made, provisions are not tax deductible. This article deals with depreciation and bad debts, which are the most common types of provisions to be found in a profit and loss statement.

Depreciation

The applicable rate of depreciation for a fixed asset is its cost divided by the number of years it is expected to be operational in the business. Depreciation is usually expressed as a percentage; so if machinery with an forecast working life in the business is ten years, its rate of depreciation will be 10%: i.e. (1-10) x 100.

Although depreciation of fixed assets is not tax deductible in the UK, it is replaced by capital allowances. In the case of most fixed assets capital allowances can offer more in terms of tax relief in the year of their acquisition than the depreciation charge.

Provision for Bad Debts

Estimates for anticipated losses as a result of bad debts must be seen as being consistent with the past performance of accounts receivable or if it is to be greater than this, as a result of specific information; for example evidence that the business failure of a customer with a large outstanding balance payable will result in a loss.

The value of a bad debt provision will not however qualify as a tax deductible overhead until the debt has been written off. As long as the agreed credit term is no greater than normal business practice (e.g. payable 30 days or by the end of the month following that of delivery) six months is the average period by which HMRC will accept writing off a bad debt against taxable profits. An important proviso however is that: "all reasonable steps have been taken to recover the debt".

The VAT on a bad debt that is more than six months old can also be reclaimed.

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