Bad Debts Recovered A/c to credit as per SFAS 154

k.sankar.ra
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Bad Debts Recovered A/c to credit as per SFAS 154

Postby k.sankar.ra » Wed Aug 03, 2016 5:17 am

First when bad debt is recognized,

Bad Debts Expense A/c Dr
Allowance for Doubtful Debts A/c Cr

Next when the same is considered uncollectible,

Allowance for Doubtful Debts A/c Dr
Accounts Receivable Cr

The net result of the above entries is that the net income was reduced
in the year in which the debt was considered doubtful.
Receivables balance was reduced in the subsequent year
in which the debt was considered uncollectible.

When the written off debt is later recovered,

Accounts Receivable Dr
Allowance for Doubtful Debts A/c Cr

Cash A/c Dr
Accounts Receivable Cr

In the first entry why would Allowance for Doubtful Debts A/c
be re-created by crediting that a/c ?
Because, money has been recovered and there is no doubtful debt at all.

Change in uncollectible receivables constitute a change in accounting estimate
under paragraph 2(a)(2) read with paragraph 2(d)(a) of
SFAS 154 on Accounting Changes, Error Corrections, etc.

Change in Accounting Estimate shall be accounted for
in the affected current and future periods only,
as per paragraph 19 of SFAS 154 aforesaid.

This recovery of bad debt previously written off
has affected the current period only.
Therefore, we have to give effect to this recovery in the current year only.

Because of this recovery, the debit to net income in an earlier year,
(through bad debts expense a/c debit transferred at year-end to net income a/c)
has become unnecessary and incorrect.

Hence, for recovery of bad debts previously written off, the entries must be:
Accounts Receivable Dr
Bad Debts Recovered A/c Cr

Cash A/c Dr
Accounts Receivable Cr

At the year-end,
Bad Debts Recovered A/c Dr
Net Income A/c Cr
(Credit to Net Income due to recovery of bad debt previously written off
to offset the debit to Net Income in an earlier year by transferring bad debts expense a/c)

Also, instead of the name "Allowance for Doubtful Debts",
a) the name must be "Allowance for Credit Losses"
as per paragraph 20(b) of SFAS 114 on Creditor Accounting for Loan Impairments,
b) or less clearly "Valuation Allowance"
as per paragraph 13 of the same SFAS 114.

Am I correct in stating this ?
Can you clarify this please ?

Regards
Ra K Sankar

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