Hi Katie,
You are right in thinking the way you are. That is one of the issues that might come up in a year or period under discussion.
But the key is that we are using this as a reference point. It is an estimate, which should ideally be the best estimate based on our understanding of the circumstances of the business and other related items.
So, even if hypothetically, you end up collecting more from one debtor than what you had estimated for the whole operations, it would not make much difference as the concept of credit losses is not to match apple to apple with each debtor account but to estimate the credit losses for the business as a whole. It is likely that someone else paid you much less, and that ideally was the trigger in the first place to create this 5% estimate.
But taking this discussion forward, if your business consistently sees collections much more than the percentage earmarked for losses, you need to adjust your loss number, which should reflect the near correct situation for the business.
If the business fails to do so, it will get flagged by the audit. Ultimately, there is no point in booking an expense higher and then showing a reversal in the same or subsequent year, as it might fall in the realm of prior period adjustment.
In a nutshell, this particular category of expense is based on best judgment and estimate. If your estimate is way off on a regular basis, then it would call for a realignment to the percentage earmarked. If it is more collection from a particular debtor only, but overall the trend is in line with the estimate, we don't worry too much about such a one-off collection.
Remember it is an estimate to the best of your knowledge and understanding, and it should help you arrive at the values which represent a true and fair value as on the relevant date.
I hope it makes sense.
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Harjjeet Gahla (ACS LLB DBF ADM)
FInancial Controller / Accountant
Calgary Alberta
Canada
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Original Message:
Sent: 04-10-2021 09:38 AM
From: Katie Mincey
Subject: Recovery of A/R Previously Written Off
In thinking through this further I have another question if you or anyone else in this thread is willing to further discuss.
When we estimate the amount of uncollectible accounts, we debit credit loss/bad debt expense. My confusion is that if we use the income statement approach (percentage of sales) to estimate uncollectible accounts, then each period we are recognizing bad debt expense based on an estimate (percentage of sales) that never gets adjusted...is that correct? This is unlike with the balance sheet (percentage of receivables) approach since with that method we adjust the allowance account at the end of the period so that the balance is our estimated amount.
What if we end up collecting more than we estimated?
For example, let's say we did $5,000 in credit sales for the period and we estimate uncollectible accounts at 10%, so we book the following entry:
Dr. Bad debt expense $500
Cr. Allowance for uncollectible accounts $500
Then we collect $4,900 on that period's credit sales and show $100 to be uncollectible, so we book the following entries:
Dr. Cash $4,900
Cr. A/R $4,900
Dr. Allowance for uncollectible accounts $100
Cr. A/R $100
Now our total bad debt expense recognized on the P&L is $500, our A/R is $0, and our Allowance account is a credit balance of $400 which renders net A/R at a $400 credit balance. We have collected all of the period's A/R except that $100 we wrote off, so isn't our bad debt expense for the period overstated at $500?
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Katie Mincey
Accountant
Indian Trail NC
United States
Original Message:
Sent: 04-10-2021 01:24 AM
From: HARJJEET GAHLA
Subject: Recovery of A/R Previously Written Off
Hi,
Kindly use the following as a standard step in all such questions, it makes it much easier.
| Allowance for Credit Losses-T A/c |
| | |
| (4) Amount actually written off as credit losses for the period | (1) Beginning balance |
| | (2) Collection of previously written-off credit losses. |
| | (3) Amount charged as credit loss expense |
| Balancing figure (balance carried/forward) | |
Sl no 3 is the entry for the current year BD expense estimate. It would use a nominal account for considering the impact on the current year P&L.
Once a year is closed and some recovery takes place, it can impact the real account and not the nominal accounts, which are closed at the end of the year.
We get cash, so it is debited. While the impact of such recovery would increase the liability to balance the account.
The final impact shall be on the debtors recognized at the end of the year and it shall be thru the Allowance for Credit losses a/c.
The key to keep in mind is that we estimate the realizable value of debtors at the year-end, based on an estimate. So the recovery would in a way increase the write-off that we have to consider at year-end.
I have tried to use a very simple explanation. Hope it helps.
You are most welcome to send me another email if the current one does not help. I will try to share some other explanations.
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Harjjeet Gahla (ACS LLB DBF ADM)
FInancial Controller / Accountant
Calgary Alberta
Canada
Original Message:
Sent: 04-09-2021 08:28 AM
From: Katie Mincey
Subject: Recovery of A/R Previously Written Off
I am studying for my CMA part 1 exam and reviewing subunit 2 on A/R and Inventory Measurement. The book outline states that the JE for recovering previously written off receivables does not affect credit loss (bad debt) expense. The JE is:
Dr. Cash
Cr. Allowance for bad debt
Why do we credit (increase) the allowance account here? The bad debt expense was recognized in the accounting for the estimation of uncollectible A/R; wouldn't we want to reverse that expense when we receive the cash? Can someone help me understand why are we increasing the allowance account instead of reversing the expense? It doesn't make sense intuitively to me.
Thank you very much for your help!
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Katie Mincey
Senior Accountant
Indian Trail NC
United States
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