Collection of an Account Previously Written off

On occasion, a company may collect an account that was previously written off. For example, a customer that was once in dire financial condition may recover, and unexpectedly pay an amount that was previously written off. The entry to record the recovery involves two steps: (1) a reversal of the entry that was made to write off the account, and (2) recording the cash collection on the account:

 6-16-X6 Accounts Receivable 1,000 Allow. for Uncollectible Accounts 1,000 To reestablish an account previously written off via the reversal of the entry recorded at the time of write off 6-16-X6 Cash 1,000 Accounts Receivable 1,000 To record collection of account receivable

It may trouble you to see the allowance account being increased because of the above entries, but the general idea is that another as yet unidentified account may prove uncollectible (consistent with the overall estimates in use). If this does not eventually prove to be true, an adjustment of the overall estimation rates may eventually be indicated.

Matching Achieved

Carefully consider that the allowance methods all result in the recording of estimated bad debts expense during the same time periods as the related credit sales. These approaches satisfy the desired matching of revenues and expenses.

Monitoring and Managing Accounts Receivable

Equally important is to monitor the rate of collection. Many businesses have substantial dollars tied up in receivables, and corporate liquidity can be adversely impacted if receivables are not actively managed to insure timely collection. One ratio that is often monitored is the accounts receivable turnover ratio. That number reveals how many times a firm's receivables are converted to cash during the year. It is calculated as net credit sales divided by average net accounts receivable:

Accounts Receivable Turnover Ratio

Net Credit Sales/Average Net Accounts Receivable

To illustrate these calculations, assume Shoztic Corporation had annual net credit sales of \$3,000,000, beginning accounts receivable (net of uncollectibles) of \$250,000, and ending accounts receivable (net of uncollectibles) of \$350,000. Shoztic's average net accounts receivable is \$300,000 ((\$250,000 + \$350,000)/2), and the turnover ratio is "10":

10 = \$3,000,000/\$300,000

A closely related ratio is the "days outstanding" ratio. It reveals how many days sales are carried in the receivables category:

Days Outstanding = 365 Days/Accounts Receivable Turnover Ratio

For Shoztic, the days outstanding calculation is:

36.5 = 365/10

By themselves, these numbers mean little. But, when compared to industry trends and prior years, they will reveal important signals about how well receivables are being managed. In addition, the calculations may provide an "early warning" sign of potential problems in receivables management and rising bad debt risks. Analysts carefully monitor the days outstanding numbers for signs of weakening business conditions. One of the first signs of a business downturn is a delay in the payment cycle. These delays tend to have ripple effects; if a company has trouble collecting its receivables, it won't be long before it may have trouble paying its own obligations.