Change in bad debts allowance and subsequent recovery of bad debts

Allowance method is based on estimation and there is a possibility that circumstances change favorably for an entity. A debtor which was considered doubtful becomes financially stable or somehow pays the amount due from him. In such circumstances, accounts receivable balance is reinstated to its original position.

Reversal of allowance for doubtful debts

If the allowance for doubtful debts was recorded previously, and the receivable is now deemed recoverable, following journal entry is made to reinstate the original receivable balance.

Allowance for doubtful debts (Contra account) – Debit
Reversal of bad debts expense (P/L) – Credit

By recording this entry, allowance for doubtful debt is reversed.

Subsequent recovery of bad debts

If the receivable was written off from the books and subsequently, the amount due is collected, following journal entries will be made.

Accounts receivable – Debit
Bad debts recovered (Other income in P/L) – Credit

Cash – Debit
Accounts receivable – Credit

Let’s take a look at the following example to understand these concepts.

Example

Let’s take the example of our previous chapter “Accounting of allowance for bad debts”. On 28 February, following are the details of accounts relevant to receivables:

  • Accounts receivable Dr. balance = $77,000
  • Allowance for doubtful debts Cr. balance = $12,000

In the month of March, the Fast Courier Co. earned credit sales revenue of $40,000 and collected $50,000 of the receivables. Furthermore, on 20th March, the company received $3,000 from a customer which was previously written off as bad debt. On 31st March, the company estimated the uncollectible receivables and concluded that the estimated doubtful debts are only $2,500, mainly because of improved financial condition of its majority customers.

Following journal entries will be made to record the allowance for doubtful debts.