Dealing with Bad Debt in Community Associations

Posted by Jeff Hardy on August 4, 2016

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Occasionally, homeowners can't or simply don't pay. When that happens, you do have options, but even with a lien, there is likely to be some amount owed that you aren't able to recover. Leaving bad debt on your books for too long skews your financial statements and can lead to unreasonable expectations of a community's financial position.

Bad debt is any amount that is uncollectible. If you're sure you won't be able to collect from a delinquent homeowner, you should write off the bad debt.

Common practice for community associations is to budget for amounts that may not be collected due to foreclosure. The budgeted amount is usually a percentage of the receivables that are in attorney collection status. You can accrue bad debt monthly, but in my management company we did not write any amounts off until after a 1st lienholder foreclosure. There are legal ways to try to collect on the remaining debt after foreclosure, but since they are typically costly and don’t result in recovering much (if any) funds, this route is rarely taken by community associations.

The generally accepted accounting practice is to record the bad debt when it has proven uncollectible. If a homeowner is in bankruptcy, then likely the amount due to the community is uncollectible and should be written off as a bad debt. Unfortunately, it's not always as clear-cut as that. There are 2 ways to handle a possible bad debt:

  1. Direct Write-off – the entire amount of the uncollectible debt is written off to expense when the amount has proven to be uncollectible, as in a bankruptcy. This would be done by an adjustment which would remove the owner balances from the books of the community. This should result in a General Ledger entry as follows*:
          Debit – Bad Debt Expense
          Credit – Owner Accounts Receivable
  2. Allowance for Bad Debt – a portion of the outstanding balance, which the community may not be able to recover, is written off to expense using a separate receivable account named “Allowance for Bad Debts” which offsets the total of all the homeowner receivables. It does not directly write-off any portion of the owners balance until it proves to be uncollectible. Rather, it just records an amount for the expected bad debt as follows:
          Debit – Bad Debt Expense
          Credit – Allowance for Doubtful Accounts

    The amount written off this way would be reversed on the books if a portion of the amount due deemed uncollectible was actually collected. This kind of entry is done using a Journal Entry. Again, the homeowner balance is not adjusted until the amount has proven uncollectible. At that point, the adjustment to the owner balances would be:
          Debit – Allowance for Doubtful Accounts
          Credit – Owner Accounts Receivable

    Once it is determined that an amount due is uncollectible, an adjustment should be made to the owner balances to write them off the books. This should result in a General Ledger entry as follows*:
          Debit – Allowance for Doubtful Accounts
          Credit – Owner Accounts Receivable

The community’s Board of Directors should establish a policy, by Board motion, that states when to recognize an uncollectible bad debt. The policy establishes the criteria the management company should use when keeping the books. But no write-off of a bad debt should occur when there are still reasonable prospects to collect the amount due. Many times, the amount can still be collected when there is a resale of the home so long as no bankruptcy is in process.

If you are considering writing a policy for bad debt write-offs, or have bad debt on your books that needs to be written off, you should contact the community’s CPA for the best accounting advice specific to your association.

* Indicates how the entry would appear in the General Ledger, not a direct GL Journal Entry

 

**Image credit: Jason Rogers via flickr

sample delinquency policy

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