6. Write Offs and Reinstatements

Let's talk about write-offs and reinstatements. So far, we've been focused on putting the bad debt expenses into the allowance for bad debts. We've spent a lot of time trying to figure out what's our bad debt expense. That was all that estimating, income statement, balance sheet, all that stuff we did. We've been focusing on this side. Now I wanna focus on this side, when you actually have to do the write-off, when an account actually goes bad and someone says, "I'm bankrupt, I'm not gonna pay you." So this is what we're gonna focus on for write-offs. Now, when you have a write-off, you're not going to be incurring an expense at all because if you'll remember, this is when we made the sale, this is when we have the write-off, this is the year-end.

And right here at the year-end, that's when we incur the bad debt expense. So when we have the write-off, we're not gonna incur another expense because we already did. Like I told you in one of the other videos, this becomes our buffer. This is our savings account or our rainy day fund. So when we actually have the write-off, we don't have to touch expenses again because we already did it. What we do touch is we decrease our buffer. We decrease our allowance for bad debts. And the way that we do that is if we have a write-off of $1,000, well, that's a bummer.

That means somebody with a $1,000 account said, "I can't pay you. I'm never going to pay you. I'm bankrupt." And that's too bad, but we have an allowance for that sort of situation. And so what we do is we decrease our allowance for bad debts by $1,000, and we also decrease our accounts receivable by $1,000 because we know we're never, ever, ever, ever gonna receive that. And so if we were to leave that in our accounts receivable, over time our accounts receivable would continue to grow because at least some portion of it would be accounts that we're never going to receive.

And we want our accounts receivable to be as clean as possible. So when we figure out that we're never ever gonna receive this $1,000, we remove it from our accounts receivable so that we don't end up with all this uncollectible stuff in our accounts receivable over time. And that's all it takes to write off a bad debt. When you see write off, you need to think, I have allowed for that situation. I have allowed for a bad debt. That's why we call it allowance for bad debts. So when you write it off, you're saying, "Okay, now it is a bad debt." So immediately you think, okay, well it has just become a bad debt, so I must adjust my allowance for bad debts.

And so we take down our allowance for bad debts and we also get that $1,000 out of our accounts receivable because by the very definition of accounts receivable, it must be able to be received, and we know that it's not able to be received. So we're gonna take that out. So this is it. That's the journal entry for a write-off. As you can see, there's not a lot to it. The hard part was in estimating all the bad debt expenses. But once you put it into the buffer or the savings account or however you wanna think of it, write-offs are super easy. You just take it out.

So you have your allowance and you take it out. Now what happens when you want to reinstate an account? So when would that ever happen? Let's say that this guy that declared bankruptcy here, the one that we've been doing this problem for, let's say John Doe says, "Hey, I just declared bankruptcy. I'm not gonna be able to pay you." We say, "Bummer. That's too bad, but also I have an allowance for that situation so I'm gonna write it off." And then a number of years later, good guy John comes back and says, "Hey, I know that I don't owe you this money because I declared bankruptcy and legally I'm not obligated to pay you.

But because I'm good guy John, I wanna pay you that $1,000 because it is important to me that I pay my debts." Now whether or not this actually happens very often is irrelevant. It's going to happen on your test. So this is called the reinstatement. This is when good guy John comes back and says, "I would like to reinstate my account with you. Bankruptcy legally cleared me from it, but because I'm a good guy, I'm going to reinstate it." So now you may be wondering, okay, thanks John, but what do I do? As an accountant, how do I handle that situation? Because I already wrote off your account.

You declared bankruptcy, I wrote it off. Now I don't know what to do. I'm just the entry level accountant. Well, first of all, we know we're not gonna put it back into accounts receivable because he came back and paid us, right? He didn't come back and say, "I would like to pay you in the future. Please reinstate my account receivable." We wouldn't do that. We would just say it's already written off. We're not gonna put it back in just to write it off again. That doesn't make any sense. So he came to us with cash and said, "I would like to satisfy my debt."

So what we do is we increase our cash by $1,000. We're not gonna put it back in accounts receivable because he paid us. And the second part of this journal entry is we're gonna put it back into the allowance for bad debts. Let's see if we can figure out why. So we took it out of the allowance for bad debts because we thought it was a bad debt. We thought, "He's not gonna pay us. I have an allowance for this situation. I have an allowance for bad debts. This is now a bad debt, so I'm gonna use my allowance." When in reality, it turned out not to be a bad debt.

It turned out he's actually gonna pay us, so we just put it right back into our allowance and save that up for some other customer that's not gonna pay us. So the reinstatement is also relatively straightforward. It's essentially an undoing of a write-off, but instead of putting it back into accounts receivable, we're just gonna put it into cash, because really you could think of it like this. So if I say that a reinstatement is the opposite of a write-off, so if the write-off is allowance for bad debts and accounts receivable, and I say reinstatement is the exact opposite, well, then you may think accounts receivable, allowance for bad debts.

That's not stupid. That makes a lot of sense, but at the same time, good guy John paid us the cash, so we would decrease our accounts receivable. So essentially we're left with cash and the allowance for bad debt, which is what we did here. So because he came to us with cash, we just skip accounts receivable altogether.

So on your test, when you see write-offs and reinstatements, you should feel a sense of ease because this is the easy part. Estimating the bad debt expenses, that's the in-depth complicated part. But the write-off is... I mean, the write-off is simple. It's a single journal entry. Reinstatement is simple. It's a single journal entry. You're filling your allowance back up, and hey, you got paid, so half the journal entry is done. Whenever you see you got paid as a part of one of the problems, alarm bells should go off in your head and think, "There's half my journal entry. I'm just gonna put cash."

And since we're dealing with the allowance for bad debt, that's gonna be your other half. You're filling your allowance back up.