Writing Off Bad Debt and Dealing with Collection Agencies
Collection agencies are often used to collect overdue receivables. Typically, the agency will take a percentage of any debt collected (40% is not uncommon), then forward the remaining portion of the payment to you. There are a variety of acceptable methods of accounting for this activity. This topic covers one recommended method only. Your accounting professional may recommend another method altogether. It is strongly encouraged to get your accounting professional’s approval prior to implementing this recommendation.
As an overview of this method, bad debt invoices are first written off from the regular Accounts Receivable account, and expensed to a Bad Debt account. These accounts are then assigned to a collection agency via an invoice. These collection accounts are subsequently tracked using a separate A/R account called “Accounts Receivable – Doubtful”. Any payments received through the collection agency are applied to the applicable overdue invoices and is recognized as income. The amount withheld by the collection agency as their fee is discounted from the overdue invoice and tracked using a separate account called “Collection Agency Fees”.
In order to use this procedure, some preliminary setup must take place. To do this properly, first go to System Preferences (Edit | Preferences) and temporarily disable Smart Account Selection Filtering from the Chart of Accounts tab. It is strongly recommended to re-enable the feature after preliminary setup is complete. See this related topic, “Preferences – Chart of Accounts” for more info.
- Create a new account named “Accounts Receivable – Doubtful”. Make the account type Accounts Receivable. See the related topic, “Chart of Accounts List” for more information on creating a new account.
- Create a new account named “Bad Debt”. Make the account type either an Expense or a Cost of Goods Sold (based on your accounting professional’s recommendation). See the related topic, “Chart of Accounts List” for more information on creating a new account.
- Create a new invoice item. Make the new item type an “Other Charge”. Name the new item “Doubtful Income”. Set the income account to “Bad Debt”. Upon saving a warning will inform that the selected income account is not of type “Income”. This is by design — leave the income account as selected. See the related topic, “Items – Add Item – Other Charge” for more info on adding items.
- Setup the collection agency as a new customer. On the Payment Info tab, in the A/R Account field, choose “Accounts Receivable – Doubtful”.
- Create a new account named “Collection Agency Fees”. Make the account type either an Expense or a Cost of Goods Sold (based on your accounting professional’s recommendation). See the related topic, “Chart of Accounts List” for more information on creating a new account.
Sending an Account To Collections
To send an overdue account to the collection agency, do the following:
Write off the bad debt using the New Payment form (Customers | Receive Payments). In the Customer field choose the customer having overdue receivables. For each invoice being turned over to collections, enter a discount for the entire invoice amount. Use the date on which the invoice is being sent to collections, and use the “Bad Debt” account for the discount account.
Place the customer on credit hold (open the customer record, go to the Payment Info tab, and tick the “Credit Hold” checkbox). This helps to prevent the customer from running up further debt.
Use an invoice to record assigning bad debt accounts to the collection agency. Create an invoice, choosing the collection agency as the customer. For each previously written off bad debt invoice, add a “Doubtful Income” item, entering the full amount being sent to the collection agency, and noting the customer and invoice number in the description field.
Receiving Money from Collections
Receive a payment from the collection agency by using the New Payment form (Customers | Receive Payments). In the Customer field choose the collection agency. Enter the payment being received in the Amount field. Tic the checkbox for the invoice being paid. The invoice balance not covered by the payment is the amount kept by the collection agency as their fee. The discount area is used to record these collection agency fees. Enter a discount for the unpaid balance due (agency fees). Use the payment receipt date, and pick “Collection Agency Fees” for the discount account.