A bad debt recovery is a payment received after it has been designated as un-collectible. This may occur after legal action has been taken to recover a receivable, as a partial payment from a bankruptcy administrator, or some similar situation. It could also arise simply because an invoice was written off too soon, before all possible collection alternatives had been explored.
A bad debt recovery can also come from the sale of a creditor’s collateral. For example, a lender might repossess a car after a borrower on a car loan has been delinquent in making payments. The lender sells the car, and the proceeds from the sale are considered a bad debt recovery.
The accounting for a bad debt recovery is a two-step process, as follows:
- Reverse the original recordation of a bad debt. This means creating a debit to the accounts receivable asset account in the amount of the recovery, with the offsetting credit to the allowance for doubtful accounts contra asset account. If the original entry was instead a credit to accounts receivable and a debit to bad debt expense (the direct write-off method), then reverse this original entry.
- Record the cash receipt from the bad debt recovery, which is a debit to the cash account and a credit to the accounts receivable asset account.
Bad Debt Recovery is a debt from a loan, credit line or accounts receivable that is recovered either in whole or in part after it has been written off or classified as a bad debt. Because it generally generates a loss when it is written off, a bad debt recovery usually produces income.
In accounting, the bad debt recovery would credit the “allowance for bad debts” or “bad debt reserve” categories, and reduce the “accounts receivable” category in the books.
ABC LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently finds out that DEF LTD is being liquidated and therefore the prospects of recovering its dues are very low. ABC LTD therefore writes off the receivable from its books. However, the administrator appointed to oversee the liquidation of DEF LTD instructs the company to pay $300 to ABC LTD in full settlement of its dues.
As $300 of the bad debt has been recovered, it is necessary to cancel the effect of previously recognized bad debt expense up to this amount. The accounting entry will therefore be as follows: