No expense on write-off; reinstate then collect; a note by days

When a customer actually fails

In March a customer who owes Bramble Lane 2,400 declares bankruptcy. The loss was already expensed — it is part of the estimate the allowance was built for — so writing the account off touches no expense at all:

Mar 15  Allowance for Doubtful Accounts    2,400
            Accounts Receivable                      2,400

The allowance was set aside for exactly this; now a name is attached to 2,400 of it. Debiting Bad Debts Expense would count the loss twice — once in the estimate and again now. And notice what the write-off does to the balance sheet: gross receivables fall by 2,400, the allowance falls by 2,400, and the net figure, net realisable value, does not move. Before: $148,000-6,370=141,630$. After: $145,600-3,970=141,630$. A write-off is a reclassification inside the asset, not a loss.

When a written-off customer pays after all

In August a customer written off last year sends 900. Two entries, always. First reinstate the account — reverse the write-off for the amount recovered — so that the customer's record shows the payment and the allowance gets its 900 back:

Aug 4   Accounts Receivable                  900
            Allowance for Doubtful Accounts            900

Then collect it like any receivable: Dr Cash 900 / Cr Accounts Receivable 900. Crediting revenue on a recovery is the trap: the sale was revenue when it was made; the recovery is the return of an asset that was estimated lost, and it goes back to the allowance the loss came out of.

A customer's note — counting the days

A customer who cannot pay a 12,000 account on time offers a 90-day, 7 % promissory note dated 1 November. Bramble Lane accepts: Dr Notes Receivable 12,000 / Cr Accounts Receivable 12,000 — one asset replaces another; no cash, no revenue.

The note's term is in days, so interest is days ÷ 365, and the days are counted excluding the day of issue and including the day of maturity. Maturity: November has 29 days left after the 1st, December 31 — that is 60; the remaining 30 fall in January, so the note matures 30 January.

31 December — accrue the interest earned. Sixty days have run:

$$12,000\times 7\%\times \frac{60}{365}=138.08$$

Dr Interest Receivable 138.08 / Cr Interest Revenue 138.08. The principal stays in Notes Receivable.

30 January — maturity. Total interest $12,000\times 7\%\times \frac{90}{365}=207.12$, of which 138.08 was last year's revenue and only the remaining 30 days, 69.04, is this year's:

Jan 30  Cash                              12,207.12
            Notes Receivable                          12,000.00
            Interest Receivable                          138.08
            Interest Revenue                              69.04

Crediting Interest Revenue for the full 207.12 counts December twice and leaves Interest Receivable uncleared — the mirror of the notes-payable trap in L6.2. If the customer does not pay, the note is dishonoured: Dr Accounts Receivable 12,207.12 / Cr Notes Receivable 12,000 / Cr Interest Receivable 138.08 / Cr Interest Revenue 69.04 — the whole amount goes back to an ordinary receivable, interest included, and is then estimated and written off like any other.

One ratio for the case

How long does Bramble Lane wait for its money? Days' sales outstanding:

$$\text{Receivables turnover}=\frac{\text{Credit sales}}{\text{Receivables}}=\frac{640,000}{148,000}=4.32\text{DSO}=\frac{365}{4.32}=84.4\text{ days}$$

Against terms of n/30, eighty-four days says the store's customers pay nearly two months late — which is the sentence an exam case wants after the number.