Provision for Credit Losses (PCL): Definition, Uses, Example

A provision for credit losses (PCL) is an amount set aside by a company to cover potential bad debts. It is a type of reserve that is used to ensure that the company has enough money to cover its losses if customers default on their loans.

The PCL is calculated based on the company's historical bad debt experience and its current credit risk. The higher the company's bad debt experience, the higher the PCL will be. The current credit risk is based on the company's current lending practices and the economic environment.

The PCL is an important part of a company's financial statements. It provides investors with information about the company's potential bad debt exposure. The PCL can also affect the company's earnings and its ability to pay dividends.

There are two main types of PCLs: general and specific. A general PCL is a provision that is made for all customers, regardless of their creditworthiness. A specific PCL is a provision that is made for specific customers who are considered to be high-risk.

The PCL is used to offset the cost of bad debts. When a customer defaults on a loan, the company can use the PCL to cover the loss. The PCL can also be used to write off bad debts.

The PCL is a valuable tool for managing credit risk. It helps companies to ensure that they have enough money to cover their losses if customers default on their loans. The PCL also provides investors with information about the company's potential bad debt exposure.

Here is an example of how a company might calculate its PCL. A company has a historical bad debt experience of 1% of its total sales. The company's current credit risk is considered to be high, so it decides to make a general PCL of 2% of its total sales. The company's PCL would be 2% * $100 million = $2 million.

The PCL would be recorded on the company's balance sheet as a contra-asset account. This means that the PCL would reduce the company's total assets by $2 million. The PCL would also be reflected in the company's income statement as an expense.

The PCL is an important part of a company's financial statements. It provides investors with information about the company's potential bad debt exposure and helps the company to manage its credit risk.