What is a bad debt?
Bad debt is money you’re owed but can’t recover, such as outstanding amounts on invoices that will never be paid.
Bad debt examples include invoices that won’t get paid, and money owed from companies that’ve gone into liquidation.
Writing off bad debt
Writing off an invoice or outstanding amount as a bad debt will keep your accounts in order, and the invoice will no longer be classed as paid.
If you don’t write bad debts off when you know the invoice won’t be paid, then your accounts receivable balance will become extremely high. This’ll mean you’re overstating the amount of outstanding invoices you have, and give you an unrealistic forecast of your projected income.
Traditionally, there are two ways to write off bad debt: using a direct write off method or using a provision method.
In both of these, you have to create a bad debt expense – which refers the loss you’ll experience due to customers not paying for goods and services you provide.
Direct write off method
This method of writing off bad debt tends to delay recognition of the bad debt expense.
If you’re sure an invoice won’t be paid, then you can charge the amount of an invoice into a bad debt expense account. This becomes a debit to your bad debt expense account and a credit to your account receivable account.
You may also have to reverse any related sales tax charged on the invoice, which’ll result in a debit on your sales tax payable account.
In this method of writing off bad debt, you charge the amount of an invoice to the allowance for doubtful accounts.
This then becomes a debit to your allowance for doubtful accounts, and a credit to your accounts receivable account. As above, you may have too debit the sales tax payable account if sales taxes were charged.
This is often considered the preferred method because it eliminates timing problems. In the direct write off method, you write bad debt off months after the actual sale. This can create a mismatch in your accounts between recording the revenue and the related bad debt expense – which creates a headache.
In the provision method, bad debt expenses are recognised immediately, even if it’s not initially clear whether these expenses will become bad debts.
So, essentially, you’re counting bad debts before they happen and leaving yourself with a worst case scenario to work from. If some of your bad debt expenses don’t become bad debts, then you might end up with more money than you forecast.
Whichever method you choose to adopt, you’ll need to create a credit memo that offsets the relevant invoice.
Writing off bad debts in KashFlow
In KashFlow, you can write off whole invoices or parts of invoices in a few simple steps. This process is designed to be quick, and eliminate the confusion caused by updating multiple accounts and cross-referencing for accuracy.
Writing off a whole invoice.
To write off an invoice or outstanding amount as a bad debt go to Invoices > Select the invoice > Click the Refund button at the bottom.
On the next page click Write this invoice off as a bad debt, you’ll then be asked to confirm the bad debts code. By default we automatically set you up one up and if you’re unsure should just use this.
The bad debts code is a section of your accounts where bad debts are recorded against; this will be reflected on your Profit & Loss report as expenditure.
This will now create a new credit note that is fully paid with the negative amount from the original invoice that you are writing off.
Writing off Part of an invoice
You will need to follow the same process as above by going to Invoices > Select the invoice > Click the Refund button at the bottom.
On the next page click Write this invoice off as a bad debt, you’ll then be asked to confirm the bad debts code.
You will then have a bad debt invoice for a full amount. The next thing to do here is to press Edit on the line item of the credit note to make adjustments by entering the net amount of the amount that will not be paid and the VAT to ensure your VAT returns are correct.
Also, under payment details of the credit note, go to Edit and edit the amount here to be the amount you are writing off rather than the whole invoice amount.
Your credit note should now be marked as paid.