Understanding Invoice Write-Offs: Why and How to Handle Bad Debt

All businesses wish that all customers would pay their invoices within the stipulated time. But in life, it is not always the case. It happens that you may get to know about a customer who is not able or willing to pay after sending the reminder and making subsequent follow-up calls. When this occurs, then it is time to write off the invoice.

Writing off an invoice removes the outstanding amount of balance in your books and makes it a bad debt. This will assist you in maintaining your accounts to the truth, and it will present the real scenario of the financial health of your company.

Reasons to Write Off an Invoice

We shall have a look at some of the most popular reasons why businesses choose to write off an invoice.

• Customer Bankruptcy: There would be no guarantee that the customer will pay in case he or she goes bankrupt or closes down. Unsecured creditors may be left empty after the assets of the customer have been liquidated, and the creditors have already been paid. In these situations, the invoice is only realistic to write off. There should be records to prove that the customer has declared bankruptcy. This gives evidence that you have made all reasonable attempts to collect payment before you have declared it as uncollectable.
• Disputed Invoices: There are instances where a customer might challenge an invoice on grounds of disputes regarding the work carried out, the quality of goods, or prices. In case the dispute cannot be settled despite negotiations, you may consider that it is not worth the time and legal expenses to pursue the payment. Writing off in this situation is useful to clear up your books and prevent the display of an exaggerated balance of receivables.
• Customer Dissatisfaction: Although you might have given the goods or services, a customer might still fail to pay, saying that he or she was dissatisfied. Although it is frustrating, on other occasions, it is better to accept the loss, particularly when seeking compensation might jeopardize your reputation or even your relationship with the customer. You have to make attempts to solve the problem or provide a reasonable solution before you write off. Only write it off in case it cannot be recovered.
• Small Outstanding Balances: When the outstanding balance (that is, the one which has not yet been paid) is extremely small, say just a few pounds or dollars, it may even incur greater expense to pursue the arrears than the sum itself. There may be an automatic cut-off of small amounts owed that businesses will write off (such as below PS10 or PS20). This makes your account clean, and you also save time on small follow-ups.
• Aging Receivables: In the case when the invoices are long outstanding, i.e., more than 6 months or a year, and efforts of collection have failed, it is safe to assume that the amount will not be recovered. Old debts clog your balance sheet and are likely to deceive you into believing that you will get more revenue than you are receiving. They can be written off so that you can reflect the actual value of your receivables, and also to plan the proper cash flow.
• Customer Fraud: In a few unfortunate cases, a customer can vanish after getting goods/services without making payments. Unless you can get in touch with them or get the amount, you will be forced to charge off as bad debt. All the information about the communication and invoices should always be kept as evidence to be able to prove the loss in case you have to demonstrate it to auditors or taxes.
• Administrative Errors: There are occasions when an invoice can be generated erroneously- it can be to the wrong customer or even in a different quantity than the actual sale. In such situations, it is not so much a bad debt but a mistake. However, you will have to do away with the wrong entry and create a new and corrected invoice where necessary. This makes your financial reports remain true.

How to Write Off a Bad Debt Invoice in QuickBooks?

QuickBooks ensures invoices are easy to manage, payments are easily recorded, and when bad debts arise, it is easy to write them off. This procedure is a little bit dependent on the version of QuickBooks employed (Online or desktop), but the concept is the same: you mark the unpaid invoice as uncollectable and ease it off your accounts receivable. We will also discuss the step-by-step process of QuickBooks Online and QuickBooks Desktop.

Writing Off Bad Debt in QuickBooks Online

To write off a bad debt invoice in QuickBooks Online, follow the following steps:

Step 1: Check for Unpaid Invoices

Go to the Sales > Customers > Customer List and pick the customer that you think will not pay. Check all the outstanding invoices and ensure that you have made every possible effort to collect money.

Step 2: Make an Expense Account of Bad Debt

• In case you do not have one, you have to create a bad debt account.
• In the Settings > Chart of Accounts.
• Click New.
• In Account Type, you have to select Expenses.
• On the Detail Type, select Bad Debts.
• Enter the name of the account as Bad Debt Expense and save it.

All of your written-off invoices will be monitored in this account.

Step 3: Develop a Credit Note for the Bad Debt

• Click​‍​‌‍​‍‌​‍​‌‍​‍‌ + New/ Credit Note (or Credit memo, depending on your region).
• Choose the same customer attached to the invoice that is not paid.
• On the Product/Service section, select Bad Debt Expense.
• Type the amount you are writing off.
• Click Save and Close.

This credit note balances the invoice that is outstanding.

Step 4: Apply the Credit Note to the Invoice

• Go to + New > Receive Payment.
• Select the customer.
• Select the invoices and credit notes that are unpaid.
• Ensure that the payment value is PS0.00 (because the credit is being used to clear the invoice).
• Click Save and Close.

The invoice is now written off, and the balance is taken off your accounts receivable.

Step 5: Verify the Write-Off

To ensure the write-off is taken into account, go to Reports> Profit and Loss and check under the Bad Debt Expense account.

Writing Off Bad Debt in QuickBooks Desktop:

Using QuickBooks Desktop, it follows a slightly different procedure:

Step 1: Preparation of a Bad Debt Expense Account

• Go to Lists > Chart of Accounts.
• Click Account > New.
• Choose Expense and click Continue.
• Type in the name of the Bad Debt Expense.
• Click Save and Close.

Step 2: Create an Item for Bad Debt

• Go to Lists > Item List.
• Click Item > New.
• Pick Other Charge for the type. 
• Name it “Bad Debt.”
• In Account, have it connected with the Bad Debt Expense account.
• Click OK.

Step 3: Create a Credit Memo

• Navigate to Customers > Create Credit ‍​‌‍​‍‌​‍​‌‍​‍‌Memos/Refunds. 
• Choose the customer with whom the invoice has not been paid.
• In the Item column, select the item that you have created (Bad Debt).
• Type the amount to be written off.
• Click Save & Close.

Step 4: Attach the Credit Memo to the Bill

QuickBooks will then ask you whether you would like to apply the memo to an open invoice after saving the credit memo. If​‍​‌‍​‍‌​‍​‌‍​‍‌ you want to apply the payment to an invoice, then just pick the invoice and confirm it.

Step 5: Review Your Accounts

You can use the path: Reports > Company & Financial > Profit and Loss Standard to confirm that the bad debt was correctly recorded in the account of Bad Debt ‍​‌‍​‍‌​‍​‌‍​‍‌Expense.

Write-Offs: The Right Way to Record Bad Debt

Bad debt is not only about getting it out of your books. It is about putting it into proper records such that your financial reports remain correct and in compliance with accounting standards. These are some of the main considerations that should be made when dealing with write-offs.

• Document Everything: The first step to write off the debt is to ensure that you have all the supporting documents that include copies of an invoice, emails, payment reminders, and any communications with the customer. Such documentation will show that the value was fair and that you actually tried to gather it. This is particularly relevant in terms of taxes since HMRC or your local tax authority might demand to be shown that the debt in question was actually uncollectable.
• Adjust VAT (if applicable): In most nations, you can recover VAT on bad debts after you have realized that those debts are uncollectable. Nonetheless, there are several requirements, including:
  • The invoice is older than six months.
  • You have written off the amount in your books.
  • The VAT of the initial sale has been taken into consideration.
    • VAT adjustment in QuickBooks automatically happens when you input the bad debt correctly, but it is always better to check the VAT report before submitting.
• Separate Write-Offs from Discounts: One error that has been made is the confusion between bad debt write-offs and customer discounts or adjustments. A discount is optional–you are deciding to lower the price for a client. A bad debt, however, is not voluntary; rather, it occurs due to the failure of the customer to pay. Maintaining these categories in isolation would make your reports reflect the appropriate causes of change in revenues.
• Update Your Accounts Receivable Reports: Review your Accounts Receivable (A/R) Ageing Report after you have written off a bad debt. The outstanding invoice should not be there anymore. This makes you remain realistic about the amount of money you are owed.
• Regularly Review and Write Off Old Debts: Do not take old invoices to the end of the year and revise them. Plan an annual or quarterly review of your A/R list. Determine those invoices exceeding your standard credit periods and decide whether those invoices can be recovered. Cleaning up your books regularly will help you not get caught by the end of the year and also increase your accuracy in financial statements.
• Learn from Bad Debts: Lessons can also be learned from bad debts. Look at your unpaid invoices to spot trends- are there specific customers, industries, or order sizes that lead to higher ‍​‌‍​‍‌​‍​‌‍​‍‌defaults?
  • Use this knowledge to tighten up your credit control policies, like:
  • Demanding deposits from new clients.
  • Tightening credit limits.
  • Credit​‍​‌‍​‍‌​‍​‌‍​‍‌ checks are performed before payment term extensions.
• Consult Your Accountant: In a situation where the decision is not clear as to whether an invoice should be written off or how it should be properly recorded, consulting an accountant would be a wise move. They not only help to clarify if the write-off can be considered a deductible expense but also make sure that the correct treatment is followed during tax ‍​‌‍​‍‌​‍​‌‍​‍‌reporting.

Conclusion

Any business does not take pleasure in writing off an invoice, and yet, it is a vital process of proper financial records. Once it is apparent that customers will not pay- because they were found to be bankrupt, or they have a dispute, or have a small balance, or any other reason- then it is better to write it off rather than have your books full of uncollectable balances. With QuickBooks, it is very simple to work with bad debt write-offs in a step-by-step process, which will make sure that each and every adjustment is correctly registered in your account under Bad Debt Expense. In the process of collecting payment, do not forget to document your endeavors to do so, regularly check your aged receivables, and apply to claim back the VAT you are entitled to.

When you do write-offs properly, you will keep your accounts clean and in order, as well as get useful information on how to better your credit and collection procedures in the future.

Frequently Asked Questions