Introduction to Accounting Treatment of Bad Debt Recovery

Bad debts treatment in accounting often requires careful management. Occasionally, a business may experience a pleasant surprise when it recovers previously written off bad debts. This phenomenon, known as bad debt recovery, necessitates specific accounting treatments and journal entries to ensure accurate financial records.

Journal Entries for Bad Debt Recovery

Journal Entry 1: Recording Receipt of Cash from a Trade Receivable Written Off as Bad

When a business recovers an amount from a trade receivable that was previously written off as bad, it records the transaction through a series of journal entries. The first step in this process involves recording the receipt of cash from the trade receivable:

Debit Dr Cash Credit Cr Trade Receivables

This entry reflects the actual receipt of cash from a customer.

Journal Entry 1 b: Cancelling the Entry Previously Made to Write Off a Trade Receivable’s Account as Bad

The next step is to reverse the previous entry where the account was written off:

Debit Dr Trade Receivables Credit Cr Bad Debt Recovery

This cancels the previous write-off and prepares the accounts for the new transaction.

Journal Entry 2: Recording Bad Debt Recovery

In many cases, bookkeepers can avoid double entries by recording the entire transaction in one step:

Debit Dr Cash Credit Cr Bad Debt Recovery

This single entry simplifies the process and ensures clarity in the financial records.

Solved Example: Mitchel and Michael Ltd.

To illustrate the practical application of these principles, let's consider a scenario involving Mitchel and Michael Ltd. The company has prepared an aged trade receivables schedule, which details the status of its trade receivables as of December 31, 2018. The company follows a sliding scale policy for its provision for doubtful debts based on the age of receivables.

Scenario Overview

Provision for Doubtful Debts Balance on January 1, 2018: 500 Recovery of Harrison Jim’s Debt: Received in full on July 17, 2018 (600) Recovery of Bay Ltd.’s Debt: Received in partial payment (300 of 500) Write-off of John Kelly’s Debt: Declared bankrupt on an outstanding amount of 320 Other Bad Debts Written Off: 460

Required Ledger Accounts

a. Bad Debts Account: This account will list the total debits for the year, including the write-off and recovery.

b. Provisions for Doubtful Debts Account: This will show the adjustments made to the provision account.

c. Bad Debts Recovery Account: This account will record the recovery transactions.

Working

To calculate the provision required as of December 31, 2018:

On 31 December 2018 Provision (Aged Receivables): 19,600 x 1% 8,400 x 2% 3,650 x 4% 425 168 146 739 Less: Provision Required after John Kelly’s Write-Off: 1320 - 320 x 10% 1000 Total Provision for Doubtful Debts Required: 739 - 1000 -261 Since it is a payable, the account will show a credit: (500 1000) - 261 1239

Conclusion

Proper handling of bad debts recovery is essential for maintaining accurate and transparent financial records. By following the appropriate journal entries and maintaining careful tracking of trade receivables, businesses can ensure compliance with accounting standards and provide stakeholders with reliable financial information.