What procedures might the auditors carry out to determine whether the provision for bad doubtful debts is reasonable?

Compare beginning allowance for doubtful accounts (BADA) to write-offs (WO). This ratio is computed each year using the beginning-of-year allowance for doubtful accounts as the numerator and write-offs of accounts receivable recorded during the year as the denominator. The beginning-allowance-to-write-offs ratio indicates how adequately the allowance accommodated subsequent write-offs. Lower ratios suggest the beginning-of-year allowance may not have been large enough to absorb impending write-offs, while inordinately high ratios might indicate the entity was accumulating excessive allowances.

It is useful to examine both the mean and standard deviation of the beginning-allowance-to-write-offs ratio over a period of several years. The mean can be compared to the benchmark figure of one to two years to determine whether a firm’s allowance for doubtful accounts balance is reasonable in relation to subsequent write-offs. Meanwhile, the standard deviation of the ratio measures volatility. A relatively low standard deviation, in comparison to the multiyear mean, signals consistency. A relatively high standard deviation indicates a volatile relationship between the allowance and subsequent write-offs.