What is a bad debt?

In plain English

When a customer will not or cannot pay after reasonable effort, you write the invoice off. The expense reduces profit and the receivable is removed.

Do not delete the invoice; write it off so the history remains.

Why it matters

Keeping an uncollectible invoice on the books overstates receivables, assets and, on the accrual basis, the income you have earned. That can lead you to plan spending around money that will never come in, and it can mislead a lender who sees receivables as a source of repayment.

Recording bad debt properly also keeps a trail. If the customer ever does pay, you can reverse the write off. If you simply delete or void the invoice, the sales history for that customer and that period changes and becomes harder to explain later.

Worked example

A $1,500 invoice is 180 days late and the client has closed. Record bad debt expense $1,500 and reduce receivables by $1,500.

How to handle it

1. Document your collection attempts, such as reminders, calls and any final notice.
2. Decide on a bad debt point with your accountant, for example after a set number of days or once a customer has closed.
3. Record a credit memo or journal entry that moves the open balance to a bad debt expense account, and apply it to the invoice.
4. Keep the invoice and notes on file in case the customer pays later.
5. If payment does come in, reverse the write off and receive the payment against the invoice.

Common mistakes

• Deleting the invoice instead of writing it off, which erases the sale from prior period reports.
• Writing off invoices under the cash basis as if they were a deductible loss, when that income was never counted in the first place.
• Waiting until year end to review old receivables, so twelve months of inflated assets go into your monthly reports.
• Recording a write off without applying it to the invoice, which leaves the invoice open on the aging report.

Not the same as: Write-off

A write off is the general act of removing an amount from the books. Bad debt is the specific case where the removed amount is a customer balance you cannot collect. See Write-off.

Go deeper

• Year-End Accounts Receivable Review and Bad Debts: How to review unpaid customer invoices at year end, decide what is uncollectible, record write-offs and keep the support.

Related terms

• Balance sheet: A report showing what a business owns, owes and the owner's stake on a specific date.
• Bank reconciliation: Comparing your books to the bank statement so both agree after accounting for timing differences.
• Asset: Something the business owns or is owed that has value, such as cash, receivables, inventory or equipment.

Common questions

General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.