Bad debts in the books
How to remove a receivable you do not expect to collect, without pretending the original sale never happened.
General information, not tax or legal advice. Whether a worthless debt is deductible, and in which year, is a tax question. IRS Topic 453 and Publication 334 discuss bad debts. Publication 535, which used to cover them, has been discontinued. This page only shows the bookkeeping patterns. It does not decide that a customer’s balance is worthless.
Two bookkeeping patterns
The direct write-off waits until a specific invoice is uncollectible. You debit bad debt expense and credit accounts receivable for that invoice. The sale stays in the period when you recorded it. The expense lands now. The allowance method estimates uncollectible accounts before you know which invoice will fail. You debit bad debt expense and credit an allowance, which is a contra-asset. Receivables on the balance sheet are shown net of the allowance. When a specific invoice later fails, you debit the allowance and credit accounts receivable. That second entry does not hit expense again.
A $600 invoice that will not be paid
You billed $600 in March. It is still open in September and the customer has gone dark. Under the direct write-off, September’s entry is debit bad debt expense $600, credit accounts receivable $600. March revenue stays. September profit falls by $600. Under the allowance method, if you already expensed an estimate, September’s entry only clears the receivable against the allowance. If you never booked an allowance, do not invent one on the day you write the invoice off and also expense it. Pick one pattern and use it.
If the customer pays after the write-off, reverse the write-off and then record the cash against the receivable. Depositing the check straight to revenue records the sale a second time. The bank reconciliation will still balance, and the profit and loss will be wrong.
What this is not
A slow customer is not automatically a bad debt. The days sales outstanding figure tells you the receivable is old. It does not tell you to write it off. A cash-method business that never recorded the receivable usually has no asset to remove; the income was never picked up. Forgiving a loan to the owner is not a customer bad debt. That is a draw or a capital transaction. Sales tax you already remitted on an unpaid accrual-basis invoice is a separate cleanup, described only in outline on the sales tax page, and it depends on the state’s credit rules. This site does not list those credits.
Sources
- IRS Topic 453, Bad debt deduction — business bad debts, including credit sales to customers.
- IRS Publication 334 — the small-business guide, which now carries the bad-debt discussion after Publication 535 was discontinued.