Bad Debts? Write them off.
What is a bad debt?
A debt is considered bad in the following circumstances:
- There must be a debt. In other words, there must have been an invoice raised that remains outstanding. Sufficient steps have been taken to recover the debt, and there is justification for no longer pursuing the debt as it has no likelihood of being recovered. Only then it is considered bad, and not doubtful.
- The debtor has died leaving no assets or insufficient assets.
- The debtor cannot be traced and no assets discovered.
- The debtor is bankrupt or in liquidation, and insufficient funds exist.
How do you account for a bad debt?
This depends on how you are recording your income in your business.
- Cash Basis: If you are recording income based on a cash basis, i.e., you recognise income in your accounting system only when it is banked into your business account, then there is no adjustment required for the bad debt as the debt would not have been included in your business income to date.
- Accruals Basis: If you are recording income based on an accrual basis, i.e., you recognise income in your accounting system when it is invoiced, then the bad debt must be treated in your accounting system. Take the debt out of debtors or accounts receivable (this is another name for debtors) and recognise it as an expense called “Bad Debt” in the Profit and Loss Statement of the business. Note: a debt does not need to be written off in the year in which it first becomes bad; however, for the business to claim a tax deduction, the debt must be written off as bad in the income year it is being claimed. For example, if a debt has gone bad during the income year ended 30 June 2018, and you want to claim it that income year, it must be written off on or before 30 June 2018.
Things to watch out for
- If the bad debt is later paid to your business after you have written it off, you need to include it as income in the income year the debt is recouped.
- If there has been a change in ownership or control of the business, and the same business has not been carried on, you cannot deduct the bad debt.
How do I record a bad debt in my accounting software?
Each software package has its own steps to properly record a bad debt. We recommend using the help function within your software to search ‘recording a bad debt’ (or similar).
Recording a bad debt in:
Source: Adapted from information on the MYOB website (https://www.myob.com).