So far, in my career, there was only one company where I was responsible for booking monthly journal entries to recognize bad debt expenses. I will describe in this post how I booked the bad debt expense entries at that company.
In my previous post, Month-End Closing Process, I mentioned that the Accounts Receivable (AR) Manager needs to run the Aging report after month-end closing and identify any doubtful accounts. These accounts usually have a 30-day or more past due balance or 16-day past due balance of over $500,000. After identifying all the problem accounts, AR Manager will produce a report and send it out to all departments that need it. The accounting department is one of them.
After I receive the report, I do a quick reconciliation between the report balance and the general ledger (GL) balance of Allowance for Bad Debts account. If the report balance is higher than the Allowance account balance, it means there are new customer accounts with bad debts added to the list. I will book a journal entry to recognize the latest liability expense for those customers. The entry debits bad debt expense account and credits allowance for debt debts account.
On the contrary, if the report balance is less than the balance of the Allowance account, two possibilities can happen under this circumstance. The first possibility is some doubtful accounts are deemed uncollectible, and thus are written off. The write-offs are done in the AR sub-ledger. Accounting is not involved in this process. However, I need to remove the written-off accounts in my Allowance for Bad Debts reconciliation. To write off a doubtful account, AR staff creates credit memos, which debit Allowance for Bad Debts account, to apply to open invoices of that questionable account.
For the second possibility, AR was able to collect from the accounts that were previously deemed doubtful. Payments are created and applied to open invoices of those accounts in the AR sub-ledger. Under this possibility, my job is booking a journal entry to credit bad debt expense account and debit Allowance for Bad Debts account. After that, I need to remove the collected accounts from my reconciliation.
In the case where bad debts were previously written off, but then payments were received for those debts, the recovery process is triggered. Similar to the write-off process, the recovery process is done by AR staff as well. Debit memos, which credit Bad Debt Expense account, are created and applied to received payments in AR sub-ledger. The accounting team has no role to play in the recovery process.