[Hola2706]

Hi,

Could someone explain to me why, in order to recover a previously written off AR, we wouldn’t adjust Bad debt expense. It looks like only balance sheet accounts get adjusted to record the payment (recovered AR) however wouldn’t our bad debt expense be off if we don’t adjust it? I’m including below the journal entries as it might be easier to understand my question based on the JEs

Record Revenue
AR (Debit)
Revenue (Credit)

Record allowance for doubtful accounts
Bad debt expense (Debit)
Allowance for doubtful accounts (Credit)

Write off uncollectible AR
Allowance for doubtful accounts (Debit)
AR (Credit)

Recover the uncollectible AR (i.e. customer finally paid us)
AR (Debit)
Allowance for doubtful accounts (Credit)

Cash (Debit)
AR (Credit)

Now I would think we would have the following entry as well, however reading the books, it seems we would stop at the previous entry

Allowance for doubtful accounts (Debit)
Bad debt expense (Credit)

If anyone could explain why we wouldn’t have the last JE I would really appreciate it!
Thanks!

[RobOh]

That entry would be the approach if you were using the direct write-off method which is not allowed for GAAP.

You are simply reversing the write-off entry so you are in the same position as if you didn't write it off. You don't debit the allowance account and debit bad debt expense for items that are paid regardless if it was written off or not.

The allowance account is usually adjusted at the end of each accounting period and is usually based on a bad debt methodology such as a percentage of receivables. That is when it would be trued up or down and would in effect reflect the recovery of that receivable (i.e. not be reserved).

I hope that helps.

[Hola2706]

Thank you! Really appreciate your reply.

The true up/ down would basically be this JE, correct?

To true it up (opposite to true it down)
Bad debt expense (debit)
allowance for doubtful accounts (credit)

[RobOh]

Yes, the allowance for doubtful accounts is a contra asset account so a credit to the allowance account would increase the balance. This is true if you are using a balance sheet approach such as the Percentage of Receivables Method or Aging of Receivables Method. The approach would be different if you used the income statement approach, Percentage of Sales. In my experience at Big 4 and in industry it has always been a balance sheet approach, but for exam purposes you should familiarize yourself with the Percentage of Sales approach.

For the exam, first ask yourself which method is being used. Then you should have no problem attacking the question once you are familiar with all the journal entries, which it looks like from your original post that you have a good understanding of the required journal entries. You got this, when you have a question on this I'm confident that you will be able to answer it.

[Author]

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