Recovery of Bad Debts
When cash is collected from a written-off account receivable, it is accounted for by reversing the write-off and recording the collection of cash.
When an account receivable is reasonably expected to be uncollectible, it is written off as bad debts expense in the period in which it becomes uncollectible. Since the write-off decision is based on judgment, it might turn out to be wrong. For example, cash might be received from a written-off account receivable when the customer’s financial situation improves or when its assets are liquidated to pay its debts, etc.
When a bad debt is recovered, two journal entries are required
- To reverse the write-off of the debt:
Accounts receivable ABC Provision for bad debts ABC
- To record the collection of cash:
Bank ABC Account receivable ABC
The net effect of these journal entries is (a) a decrease in bad debts expense for the period when the provision for doubtful debts is adjusted at the end of the period and (b) an increase in cash.
Redway, Inc. (RD), a major client of Pluscore, LLC (PS) went bankrupt in financial year 2014. At the time of its bankruptcy, RD owed PS an amount of $3.5 million. During the financial year ended 31 December 2014, PS wrote off RD account as follows because it expected zero recovery.
|Provision for bad debts||$3,500,000|
In the first half of financial year 2015, a court appointed a major accounting firm as RD liquidator which had significant success in getting maximum cash for the company’s assets. In the second half of financial year 2015, PS received a cash of $2,100,000 as the final settlement of $3.5 million due to it from RD.
PS shall recognize the recovery by proportionately reversing the related write-off:
|Provision for bad debts||$2,100,000|
Cash received is recorded as follows:
Written by Irfanullah Jan