What it means
Recoveries happen more often than most managers expect. A customer's business improves, a collection agency finally gets a response after a year of silence, or a bankruptcy estate pays out a few cents in the dollar to unsecured creditors long after everyone stopped hoping.
Under the allowance method the entry has two steps. The receivable and the allowance are reinstated for the amount recovered, then the cash receipt is recorded against that receivable, so the credit lands in the allowance rather than in sales.
The practical effect is a lower bad debt expense in the current period. A larger allowance balance means a smaller top-up is needed to reach the level the ageing analysis requires, which quietly improves reported profit.
Under the direct write-off method the mechanics differ, because there is no allowance to restore. The recovery is credited to a recovery income line instead, and either way it must never be reported as revenue, since that would count the same sale twice.
Commercially, recoveries are worth pursuing but rarely worth pursuing at any cost. Agency fees of 20% to 40% of the amount collected are normal for aged debt, and legal action frequently costs more than the balance in dispute is worth.
In practice
Real-world examples
Example 1
A dental equipment supplier wrote off $9,000 owed by a practice that closed. Two years later the former owner opens a new practice, wants the same supplier, and pays the old balance in full as a condition of reopening the account.
Example 2
A telecoms provider sells a bundle of written off consumer accounts to a debt purchaser for eight cents in the dollar. The cash is small, but it is recognised as a recovery and it removes an administrative burden from the credit control team.
Example 3
A construction subcontractor receives a distribution from a failed main contractor's insolvency two and a half years after writing off $140,000. The payout of $21,000 arrives in a period when trading is weak and reduces that year's bad debt charge noticeably.
Think of it
Imagine lending your favourite jacket to a neighbour who moves away without returning it, so you assume it is gone forever and clear it from your wardrobe. Two years later, they knock on your door, hand you the freshly cleaned jacket, and apologise for the long delay.
Formula
Calculation
Recovery rate = amount recovered / amount written off
Net recovery = amount recovered - collection costs
A business wrote off a $12,000 invoice fourteen months ago after the customer stopped responding. A collection agency traces the customer, who has since refinanced, and negotiates payment of $7,500. The recovery rate on that account is $7,500 / $12,000 = 62.5%.
The agency charges 25% of what it collects, so its fee is $7,500 x 25% = $1,875 and the net cash received is $7,500 - $1,875 = $5,625. Across the whole portfolio the same year, $180,000 was written off and $27,000 eventually came back, giving a portfolio recovery rate of $27,000 / $180,000 = 15%. That 15% is the figure the finance team should build into next year's loss estimate rather than assuming written off means gone forever.Case study
Seen in the real world
The following is a fictional and illustrative story. Ashcombe Textiles, an invented fabric wholesaler, wrote off $310,000 of receivables across a difficult year when several small clothing brands failed. The credit control team was cut back at the same time, on the reasoning that written off accounts no longer needed managing.
A new financial controller took a different view and ran a simple exercise: every account written off in the previous three years was checked against public company records for signs of the owners trading again. Of $740,000 written off across those years, $96,000 was collected over the following nine months, a recovery rate of about 13%, at a cost of one part time collections officer.
In this illustrative case the recoveries did more than deliver cash. Because the allowance was reinstated as each amount came in, the following year's bad debt expense fell, and the historical recovery rate gave the company an evidence-based reason to soften its loss assumptions on the oldest ageing band.
Watch out
Common mistakes
- Recording a recovery as sales revenue, which counts the same transaction twice and overstates turnover.
- Assuming a written off debt is legally extinguished, when the customer still owes the money and the write-off is only an accounting decision.
- Ignoring recovery history when setting the bad debt reserve, which leads to consistently over-provisioning against old receivables.
Questions
People also ask
Does a recovery increase profit?
Indirectly, since it raises the allowance balance and therefore reduces the bad debt expense charged in the current period.
How long should a business chase a written off debt?
Until the local limitation period expires or the cost of chasing exceeds the realistic recovery, whichever comes first.
Should recoveries be credited back to the sales team's bonus?
Rarely, since the original sale has already been rewarded, though some companies pay a small incentive to whoever actually collects the cash.