Cook the bacon in a Dutch oven over medium-high heat until crisp. Remove the bacon, crumble, and set aside.
Add the mushrooms and shallot to the pan drippings, and sauté for about 5 minutes, or until the mushrooms are tender.
Remove from the Dutch oven and set aside.
Add the cubed potatoes and the chicken broth to the Dutch oven and bring to a boil. Cover, reduce the heat, and simmer for around 12 minutes, or until the potato is very tender.
Transfer the entire potato mixture to a food processor and puree until completely smooth, or use a hand blender.
Return the mixture to the Dutch oven and add the milk, mushroom mixture, sherry, salt and freshly ground black pepper.
Cook the soup over low heat for about 15 minutes, or until it is thoroughly heated and the flavors have blended.
Ladle the soup into bowls and top with the crumbled bacon.