What are Bad Debts Recovered?
Bad debts recovered refer to amounts that a company had previously written off as uncollectable but has subsequently been able to collect from debtors. When a bad debt is recovered, it is accounted for as revenue in the period in which the recovery occurs. This recovery can either replenish the bad debt expense previously recorded or increase the company’s income.
Recovery of bad debts improves the financial health of a business by recovering amounts that enhance liquidity and overall profitability.
Detailed Explanation
During regular business operations, companies often extend credit to customers, expecting repayments over time. However, due to factors like bankruptcy or refusal to pay, some debts become uncollectible, or “bad debts.” These are written off as expenses in the profit and loss account.
If, at a later date, these previously written-off amounts are recovered, they are termed as ‘bad debts recovered’. The accounting treatment involves crediting the amount recovered to the same account or provision where the bad debt expense was initially recorded, thereby improving the financial statements for the recovery period.
Examples
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Example 1:
- A company writes off $5,000 as a bad debt in January. In June of the same year, it recovers $1,000 from this amount. The $1,000 would be recorded as bad debts recovered and credited to the profit and loss account for June.
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Example 2:
- An organization has a provision for bad debts amounting to $20,000. It writes off a customer’s $3,000 debt. Eight months later, the customer pays $3,000. The recovered amount would reduce the provision for bad debts.
Frequently Asked Questions
1. How are bad debts initially recorded in the books? Bad debts are initially recorded as an expense in the profit and loss account and are subsequently written off from accounts receivable.
2. Do bad debts recovered affect net income? Yes. Recovering bad debts increases net income, as the recovered amount is added back to revenue or reduces the expense.
3. Are bad debts recovered considered cash inflows? Yes, when a bad debt is recovered, it is considered a cash inflow, improving the cash positon of the business.
4. How is the recovery of bad debts recorded if there was a provision for doubtful debts? If there was a provision for doubtful debts, the recovery would be credited against this provision, reducing it.
5. Should bad debts recovered be reported separately? Yes, often it’s good practice to report them separately to provide transparency and clarity in financial reports.
Related Terms with Definitions
1. Bad Debts: These are accounts receivable that a company does not expect to collect and officially writes off as expenses.
2. Profit and Loss Account: Also known as the income statement, this financial statement summarizes revenues, costs, and expenses incurred during a specific period.
3. Doubtful Debts: These are accounts receivable that a company estimates may become bad debts based on historical trends or specific account evaluations.
Online References
- Investopedia on Bad Debt Recovery
- AccountingCoach: Bad Debts Expense and Allowance for Doubtful Accounts
- Corporate Finance Institute: Bad Debt Recovery
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Financial Accounting” by Robert Libby, Patricia Libby, and Frank Hodge
- “Accounting For Dummies” by John A. Tracy
Accounting Basics: “Bad Debts Recovered” Fundamentals Quiz
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