[IMGCAP(1)]In many businesses the accounting for accounts receivable utilizes the allowance method to provide a reasonable estimate of the net collectability of the firm’s trade receivables.

Most businesses establish the allowance for uncollectibles (sometimes called allowance for bad debts) by stratifying the total receivables into aging time cohorts, as shown below:

 

 

 

 

 

 

 

 

 

[IMGCAP(2)]At the end of the day the schedule above estimates that approximately 83.10 percent of the total receivables of $4,200,000 will be collected. Therefore, the gross receivable on the balance sheet will show $4,200,000. In addition, the contra asset account, allowance for uncollectibles, will show $710,000. 

So far so good.  The business has properly accounted for their reasonable expectations of the collectability of their gross accounts receivables and provided disclosure either directly on the balance sheet or in a footnote to their financial statements as to the amount they believe will be uncollectible. The business has achieved the accounting goal of matching period revenues with period expenses by adjusting the net revenues earned. Remember, sales was originally credited and receivables originally debited and now by estimating receivable collectability a contra asset allowance for Uncollectibles is credited and uncollectible or bad debt expense is debited.

At some point in the future the business may determine that a particular account will not be collectible at all and prepare the following journal entry.

Debit                   Allowance for Uncollectibles              $5,000
Credit                  Accounts Receivable                           $5,000
To account for receivable written off.

All other things being the same, the net receivable, i.e. gross receivable less allowance for uncollectibles remains the same because both the gross receivable and allowance account are adjusted by the same amount, in this case $5,000.

Again, so far so good.  However, what happens if the written-off account decides to pay the amount owing to the business at some future time? Accounting practice says we prepare the following journal entries:

Debit                   Accounts Receivable                              $5,000
Credit                  Allowance for Uncollectibles                 $5,000
To reinstate account receivable previously written off.


Debit                   Cash                                                 $5,000
Credit                  Accounts Receivable                      $5,000
To record payment of account previously written off.

Herein lies the problem, or as I call it, the “odd accounting.” In recording the above journal entry we now have the correct cash and accounts receivable balance. However, we now have an “additional” $5,000 in the allowance account that was originally established in an earlier period to account for estimated uncollectibles as at the end of that period. We properly recorded our estimates based on our aging schedule, and now some time later, let’s say, three years, the customer makes payment. 

I believe that the accounting for that payment does not belong as an adjustment or reinstatement of the allowance account but as a revenue account called “recovery of amounts previously written off.” The reasoning is that the customer’s payment in a subsequent period is the result of his action in that subsequent period and should be matched with that act. No violation of the matching principle has been violated. 

In addition, some may say that this new revenue account “recovery of amounts previously written off” rightly should offset against the uncollectible or bad debt expense account in the period of collection. To wit, I say no. The uncollectible or bad debt expense of the period relates to the sales of the period, adjusted for changes in gross receivables, whereas the “recovery” account relates to other factors unrelated to the collection process.

One final thought: If the “recovery” account begins to become busy or active, that would surely suggest that the write-off process is too quick.

What do you think?

Charles J. Pendola, CPA, ESQ, FHFMA, FACHE, CMC, CFE, CFF, CGMA, is interim director of the Office of Graduate Management Studies at St. Joseph's College in Patchogue, N.Y.

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