An example in a small business context: at the end of the year I do my audited accounts and I have a €1000 invoice outstanding to Mr Anderson for cigars I sold him. This invoice is an asset because it’s money owed to me. My auditor asks me if I’m really going to get this money back. I concede than Mr Anderson is a deadbeat, has had a receiver appointed, and has fled to his Cape Verde apartment. Therefore it’s uncertain that I will recover the money, but I’ve appointed a bounty hunter to go find him so I’m not ready to completely write it off. I’m in the same situation with Luan and Barney Gumble, too. The auditor and I agree that one of them will probably end up paying, but not all three. I provision for €2000 in bad debts to cover the three of them. That €2000 is an expense and reduces my profits for the year (which is nice because I then don’t have to pay tax on that amount).
But lo and behold, my bounty hunter comes through and drags two of them back, at which point I have them attached and committed until they pay. I end up getting and extra €500. This €500 that was previously a bad debt provision can now be written back, i.e. the provision reversed. It counts as income (the opposite of an expense, which his what the provision was). That’s nice because it looks a bit like real money I earned if you just glance at the media reports of my accounts.
Provisioning for loan impairment is an essential part of correct bank accounting but is also a slush fund since it can be completely subjective who is going to pay and who isn’t. There are meant to be uniform rules about what to provision for but for realz the banks can manipulate the numbers. If you’re already having a shitty quarter it’s quite handy to lob in some extra impairments that you an release later to make yourself look good down the road. etc. Works well when you have new management etc. Write stuff down, blame the old guys, then release it next quarter and take the credit.