Question

Why we do not cancel out allowance for doubtful accounts when costumors finally pay to us(recovery)? I mean is it possible that there is zero in accounts receivable but something credit in allowance for doubtful accounts? I mean when costumors pay all the payments, what is meaning of existence of allowance for doubtful accounts and bad debts expense?

Answer 1

The provision for doubtful debt is usually created on the basis of a certain percentage of total account receivable which is generally computed using historical data or on industry norms. It is created to cover the expenses on non-payment of accounts receivable under the accrual basis to account for the expense in the period when the invoice is made instead of waiting for uncertain period to actually determine the loss due to bad debt. When bad debt needs to be written off, it is adjusted against the provision made. From time to time, assessment of the allowance needs to be made in order to determine if the amount is further allowance needs to be charged or it needs to be reduced.

Since, the allowance is not made against a particular customer, but on entire accounts receivable, the business need not write back the allowance when the amount is recovered from a single customer. However, in the event, that extra allowance was charged on particular debtor and more payment is received from the debtor, the extra provision may be reversed.

In the event when the balance in accounts receivable is zero, there can be no loss on account of non payment by debtors as no amount is actually receivable from them. Hence, no amount is required in the allowance for doubtful debts accounts. Thus, this amount needs to be written back, unless the business thinks that provision would be required to meet the future requirements of the business.