Bad debt is a term for accounts receivables that will never get collected.
Many business owners simply leave the balance on the books and never do anything about it because they don’t know how. This, however, does apply only to accrual basis accounting since in a cash basis business there are no receivables and therefore no bad debt.
There are two accounting techniques for charging off bad debt: the direct write-off method and the allowance method. The directions below follow the direct write-off method, where the actual amount of uncollectible accounts receivable is deducted from the sales revenue in the accounting period in which they are determined to be uncollectible, instead of creating an entry in the period in which those sales occurred.
When you are ready to write off the bad debt in QuickBooks, you should follow these steps:
Set Up Your Account
If you do not already have a bad debt expense account in your chart of accounts, you should set that up first. Then, go to products and service under the gear icon and create a service item called bad debt for coding on your invoices. This item should be coded to post to the bad debt expense account.
Credit the Customer
Next, using the quick create icon, create a credit memo for that customer. Use the bad debt item and description in the credit memo to write off the debt. Save the transaction. In the backend, the accounting for this transaction will be an increase to your bad debt expense account and a decrease to your accounts receivable.
Apply the Credit
Lastly, go to the customer’s name in your customer list. Select receive payment next to that invoice. Apply the credit against the invoice so that it no longer appears in your aging report. The uncollectible debt will now appear on your profit and loss account under bad debt expense.
Memo & Reporting
On the original invoice indicate in the Invoice Memo that it is written off. Otherwise, you could write a note in the Client Notes Section.
We also recommend that you create and save a customized client report of Bad Debt Expense organized by Customer name that can be included in the monthly client reporting package.
Undoing a bad debt entry when a customer pays
If a customer pays off an amount owed to you that you have already written off as bad debt, you will need to void the credit memo that was used to record the bad debt. This will keep the record of the bad debt while reinstating your customer’s balance. Now you can go to Receive Payments as you normally would to apply your customer’s payment.
If you’ve already written this bad debt off in a prior year, please consult your accountant or tax preparer before making these changes.
Writing off bad debt amounts to more than just the amount of the debt. For instance, if you write off $5,000 in debt this year and operate on a 10 percent profit margin, you will have to sell $50,000 to make up for the bad debt.
Since bad debt hurts your business’ bottom line so much, you should take every precaution to avoid it. Here are some ideas:
- Follow up on all past due invoices immediately
- Keep communications open with late-paying clients
- Offer discounts for early payments
- Don’t be afraid to use collection agencies as a last resort.
At Stenson Bookkeeping Simplified we provide bookkeeping training and best practices that make your company and staff the skills to be significantly more effective. Email, text or phone John L Mottram, at email@example.com or 214-543-1855 or go to our website at www.stensonfs.com. We are ready to help you.