Companies write off debts that they deem as uncollectible. This write-off is often called bad debt. In most cases, it occurs when a debtor fails to repay their debt. When companies consider the repayment chances to be virtually low, they can write it off as a bad debt. Usually, it occurs when the debtor fails to settle their balance beyond the agreed time. Sometimes, however, companies may also recover bad debts.
What is Bad Debt Recovery?
Bad debt recovery refers to a payment that companies receive for a debt written off as bad. In other words, it represents any settlement from debtors after being considered a bad debt. Usually, bad debt recovery occurs after a long time from when companies write off a debtor’s balance. Bad debt recovery applies to any amounts owed to a company by its debtors. These can be loans, receivables, or credit facilities.
Bad debt recovery is often rare for companies. Once a debt goes bad, the recovery chances are unlikely. However, companies may sometimes deem a balance irrecoverable without proper consideration. On top of that, some debtors may also recover from financial difficulties and settle their unpaid amounts. In these cases, bad debt recovery occurs.
What is the journal entry for Bad Debt Recovery?
Bad debt recovery represents an income for companies. It is because the initial transaction gets treated as an expense. When a company writes off a debtor balance as bad, it uses the following journal entry.
| Dr | Bad debt expense |
| Cr | Accounts receivable |
When the debt is recovered, the journal entries will be the opposite. This process entails reversing the original entries recorded by recording an income. The journal entry, in this case, will be as follows.
| Dr | Accounts receivable |
| Cr | Other income |
On the other hand, companies must also record the cash or compensation received. Therefore, the accounting treatment of bad debt recovery must also consider that. Companies can use the following journal entry to record the recovered amount.
| Dr | Cash or bank |
| Cr | Accounts receivable |
Companies may also record the bad debt recovery in one journal entry. This journal entry includes the net effect of the above two accounting entries.
| Dr | Cash or bank |
| Cr | Other income |
What is the tax treatment of Bad Debt Recovery?
The IRS segregates bad debts into two categories, business, and nonbusiness. For companies, most bad debts fall under the former category. When a company writes off bad debt, it can deduct it from its gross income for a tax year. However, it must have included that amount in its income or loaned out cash. Besides that, it must also ensure the bad debt meets other conditions.
On recovery, the company must include that amount as a part of its gross income. However, it must have claimed that amount as bad debt earlier. If the company deducted a lower amount before, the value included in the gross income is limited to that. If the bad debt did not reduce the tax earlier, the company must exclude it from gross income for that period.
Conclusion
Bad debt is an amount written off by companies for debts they deem irrecoverable. Sometimes, though, they may recover those debts later. This process falls under bad debt recovery. The accounting treatment of bad debt recovery requires reversing the original entry. Companies must include the recovered amount in their gross income for the tax treatment.
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