Bad debt recovery is an attempt to secure a partial or full payment of a debt that has been written off due to non-payment. Businesses sometimes conduct this type of activity after taking steps to designate the amount of the debt as uncollectable within the company’s accounting records. For this reason, any amount that is collected as a result of bad debt recovery efforts is often treated as new income.
Just about every business has experienced some amount of bad debt at one time or another. Banks sometimes write off negative balances on overdrawn accounts as a bad debt, if efforts to motivate the customer to make a deposit and restore the balance to zero prove fruitless. Credit card providers sometimes dismiss balances on accounts as being uncollectable, rather than continuing to carry the balances in their receivables. It is not unusual for a company to include a budget item that is known as an allowance for bad debt, using the resources of that account to cover uncollectable debts. While this helps to keep the accounting records accurate, it does not prevent the recording of later transactions in the event that full or partial bad debt recovery takes place.
What many consumers do not realize is that once a debt has been written off as being bad or uncollectable, the business may still take steps to recover at least part of the loss. One approach is to assign the bad debt to a collection agency, allowing that entity to move forward with attempts to contact the debtor and arrange a repayment schedule. This solution often calls for the collection agency to keep a percentage of the collected amount as compensation for its efforts. Once the percentage is deducted, the remainder of the collected amount is forwarded to the original creditor, where it is documented as a recovery from a bad debt line item.
A second approach to bad debt recovery involves selling the uncollected debt to another business. With this solution, the original creditor sells the debt for a small percentage of the total outstanding amount. The buyer assumes the risk of being able to collect the entire amount, while the original creditor can record a partial recovery of the bad debt in its accounting records, effectively closing the matter entirely.
Since companies tend to write off bad debt and remove the balance of the debt from their receivables, the process of bad debt recovery usually calls for any portion of the recovered debt to be treated as income. Most companies do have specific procedures for documenting the source of the income, so that it is possible to differentiate the collected amount from other sources of income, such as earnings from sales or dividends from investments. In some instances, the process involves entering a set of postings that debit the receivables and tying the transaction back to the original write-off. This approach effectively offsets the write-off at least in part, while still documenting the history of the transaction from the date of the write-off all the way to the receipt of the collected revenue associated with the bad debt.