• Version 1.0

• Prepared by: @Lorraine Sebata

• Approved by: @Marcia Wilkinson

• Reviewed date: 2025-09-17

• Next review date: 2026-09-17

1. Purpose

This SOP outlines the methodology and procedures for managing and calculating the Bad Debt Reserve (Allowance for Loan Losses) at Easyterms. Its purpose is to ensure that the company's financial statements accurately reflect the estimated uncollectible portion of its loan portfolio, comply with accounting standards and regulatory requirements, and provide a prudent buffer against potential loan losses.

2. Scope

This SOP applies to all loan products offered by Easyterms and involves the Finance Department, Credit Department, and Management in the regular assessment, calculation, and approval of the Bad Debt Reserve.

3. Related Policies

• Credit and Loan Approval Policy

• Financial Reporting Policy

• Debt and Recovery Collection Policy

4. Roles and Responsibilities

• Accounts Department: Responsible for the monthly/quarterly calculation of the Bad Debt Reserve, maintaining supporting documentation, ensuring compliance with accounting standards, and preparing relevant financial reports.

• Provides data on loan performance, loan classifications, and insights into portfolio quality and specific problematic loans

• Management (CFO/CEO): Reviews and approves the calculated Bad Debt Reserve, ensuring its adequacy and alignment with the company's risk appetite and strategic objectives.

• External Auditors: Review the Bad Debt Reserve calculation and methodology during annual audits.

5. Procedure: Bad Debt Reserve Management and Calculation

5.1 Data Collection and Loan Portfolio Segmentation

At the close of each reporting period, the Finance Department will obtain a loan portfolio report from the Loan Management System (LMS). This report includes reserve ratios determined by external auditors based on default likelihood and loan ageing, providing essential data for bad debt reserve calculations.

The report will detail:

• Total outstanding loan principal.

• Loan aging analysis, categorizing loans by days past due (e.g., 1-30, 31-60, 61-90, 91-180, and 181+ days).

• Loan classification (e.g., Standard, Watch, Substandard, Doubtful, Loss), adhering to theCredit and Loan Approval Policy .

• Specific details for large or problematic loans that necessitate individual assessment.

• Historical loss rates for each loan aging category and classification.

5.2 Loan Classification and Impairment Assessment (Credit Department)

• Loan Classification: The Credit Department is responsible for reviewing the entire loan portfolio to ensure all loans are accurately classified in accordance with our Credit and Loan Approval Policy. This process also involves identifying any individually impaired loans.

• Impairment Assessment: For loans identified as individually impaired (e.g., large loans with specific repayment concerns or those impacted by bankruptcies), the Credit Department will provide a thorough assessment of the estimated recoverable amount. This assessment will take into account any collateral held and the proposed repayment plans.

5.3 Calculation of Bad Debt Reserve (Finance Department)

The Bad Debt Reserve will be calculated using a combination of specific and collective provisioning methods:

5.3.1 Specific Provisioning:

• 5.3.1.1 For individually impaired loans identified by the Credit Department, a specific provision will be calculated based on the difference between the loan's carrying amount and the present value of its estimated future cash flows (discounted at the loan's original effective interest rate), or the fair value of collateral if recovery is solely from collateral.

• Formula: Specific Provision = Carrying Amount - Recoverable Amount

5.3.2 Collective Provisioning (Aging-Based or Classification-Based):

• 5.3.2.1 For homogenous groups of loans (typically smaller loans not individually assessed for impairment), a collective provision will be calculated based on historical loss experience and current economic conditions.

• 5.3.2.2 Aging-Based Method (Example):

  • Apply historical loss percentages to each aging bucket of the outstanding loan portfolio.

  • Example Loss Rates (to be reviewed and adjusted periodically):

    • Current (0 DPD): 0.5%

    • 1-30 DPD: 2%

    • 31-60 DPD: 10%

    • 61-90 DPD: 25%

    • 91-180 DPD: 50%

    • 181+ DPD: 80% - 100% (depending on collateral/recovery prospects)

  • Formula: Collective Provision = ∑(Outstanding Balance in Bucket × Loss Rate for Bucket)

• 5.3.2.3 Classification-Based Method (Alternative/Complementary):

  • Apply provisioning rates based on the loan classification (e.g., Standard, Watch, Substandard, Doubtful, Loss) as defined in the Loan Classification and Provisioning Policy (FIN-003).

  • Example Provisioning Rates (to be reviewed and adjusted periodically):

    • Standard: 0.5% - 1%

    • Watch: 5%

    • Substandard: 20% - 30%

    • Doubtful: 50% - 75%

    • Loss: 100%

  • Formula: Collective Provision = ∑(Outstanding Balance in Class × Provisioning Rate for Class)

5.3.3 Total Bad Debt Reserve:

• 5.3.3.1 The total Bad Debt Reserve is the sum of specific provisions and collective provisions.

• Formula: Total Bad Debt Reserve = Specific Provisions + Collective Provisions

5.4 Review and Adjustment (Finance Department & Management)

• 5.4.1 The Finance Department will prepare a detailed "Bad Debt Reserve Calculation Report" (Appendix A) outlining the methodology, supporting data, and the calculated reserve amount.

• 5.4.2 This report will be reviewed by the Head of Finance and presented to Management (CFO/CEO) for approval.

• 5.4.3 Management will assess the reasonableness of the reserve, considering:

  • Changes in economic conditions.

  • Changes in lending policies or credit risk.

  • Portfolio growth or contraction.

  • Effectiveness of debt collection efforts.

  • Regulatory requirements and auditor recommendations.

• 5.4.4 Any adjustments deemed necessary by Management will be incorporated into the final reserve amount.

5.5 Journal Entries and Financial Reporting (Finance Department)

• 5.5.1 Once the Bad Debt Reserve is approved, the Finance Department will record the necessary journal entries to adjust the Allowance for Loan Losses account and the Bad Debt Expense account.

• Example Journal Entry (to increase reserve):

  • Debit: Bad Debt Expense

  • Credit: Allowance for Loan Losses

• 5.5.2 The updated Bad Debt Reserve will be reflected in the company's financial statements (Balance Sheet and Income Statement) in accordance with the Financial Reporting Policy.

5.6 Write-offs (Accounts Department)

• 5.6.1 Loans deemed uncollectible after all reasonable collection efforts have been exhausted (as per Debt Collection Policy OPS-002) and approved by Management will be written off against the Allowance for Loan Losses.

• Example Journal Entry (to write off a loan):

  • Debit: Allowance for Loan Losses

  • Credit: Loans Receivable

• 5.6.2 Written-off loans will continue to be monitored for potential future recovery.

6. Documentation and Forms

• Loan Management System (from LMS) Reports (Aging, Classification)

• Bad Debt Reserve Calculation Report (from LMS)

• Credit Department Impairment Assessments

• Management Approval Records for Bad Debt Reserve

• Journal Entries for Bad Debt Expense and Allowance for Loan Losses

• Write-off Authorization Forms

7. Training

Relevant staff in the Finance and Accounts Department will receive mandatory training on this SOP, the Loan Classification and Provisioning Policy, and the Debt Collection Policy annually or upon significant revisions.

8. Review and Revision

This SOP will be reviewed annually by the Finance and Accounts Department to ensure its continued effectiveness, compliance with accounting standards and regulatory requirements, and alignment with the company's risk management objectives.