Individual valuation allowance

Also known as: Allowance for bad debts

The individual value adjustment is a method from financial accounting (accounting) to reevaluate a company's receivables that have a high risk of default.

Definition / explanation

The individual value adjustment (EWB) serves to improve the valuation of the company in the course of drawing up a balance sheet. The subject of the assessment are claims that a company has against third parties. The receivables are examined individually with regard to a risk of default. The risk is specifically determined and set against the amount of the nominal claim as an amount reducing the value. The reduced exposure value is to be accounted for.

The formation of an individual value adjustment is regulated in the Commercial Code. The general valuation principles of proper bookkeeping apply, as stipulated in Section 252 of the German Commercial Code (HGB). In particular, the principle of caution is to be assessed, but also the question of Lowest value principle has to be strictly observed. This means that in addition to a partial value adjustment, a total loss of the receivable must also be accounted for.

Calculation of the individual value adjustment

Book value of the receivable (nominal amount)
- expected default amount
+ possible security recovery
= Book value of the receivable for impairment

Example A.
Das Unternehmen hat eine Forderung von 100.000 EUR an einen Kunden. Zum Balance sheet date 31.12 besteht Kenntnis, dass der Kunde Insolvenz eingereicht hat und das Bankruptcy proceedings mangels Masse abgelehnt ist. Sicherheiten können keine verwertet werden.
This claim is to be corrected in full and included in the balance sheet with the value zero.

Example B.
The company delivered goods worth EUR 100,000 to a customer. The payment term has elapsed several weeks, the customer does not respond to any reminders. A check of its creditworthiness shows a deterioration. According to the principle of prudence, the default amount should be set at 60 percent, for example. This means that the claim is only to be included in the balance sheet in the amount of 40 percent of the nominal amount.

Flat rate assessment

Basically, the individual value adjustment is very complex, as it requires extensive investigations into the creditworthiness of the customers. This is difficult in practice because many companies have a very large customer base. However, since bad debts are very likely to occur, a general valuation can be carried out as an alternative to more precise individual value adjustments.

particularities

In the methodical approach, it is also important to note which accounting standard the balance sheet is drawn up according to. In addition to the HGB, accounting according to the IAS / IFRS standard is also possible. This leads to different results for the individual value adjustment.

Summary

  • Individual value adjustment is a method for re-evaluating a company's receivables
  • is used for receivables with a high default risk
  • As an alternative to individual value adjustments, general valuations can also be carried out
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