How to Account for Bad Debt When an Invoice Will Never Be Paid

What Is Bad Debt?

Bad debt is a business debt — typically an unpaid invoice — that has been deemed uncollectible. The client has not paid, cannot pay (insolvency, bankruptcy), or has disappeared, and further collection efforts are not reasonable.

Leaving bad debt on your books as a receivable overstates your assets and understates your costs. Writing it off keeps your accounts accurate.

When to Write Off a Debt

There's no universal rule, but consider writing off a debt when:

The debtor is insolvent or bankrupt (you'll receive formal notice)

Significant time has passed (90–180+ days) with no response to multiple reminders

A collection agency or solicitor has advised the debt is unrecoverable

The cost of further collection exceeds the likely recovery

You've made a commercial decision to write off a small amount rather than damage a relationship

Writing off a debt doesn't mean you stop pursuing it — it means you adjust your accounting records to reflect reality. If the client later pays, you reverse the write-off.

The Accounting Entry

Under accrual accounting (where you record income when invoiced):

When you write off a debt, you:

Remove the receivable from your balance sheet (debit Bad Debt Expense, credit Accounts Receivable)

This increases your expenses (reducing taxable income) and removes the asset from your balance sheet.

Under cash accounting (where you record income when received):

If you never received the cash, the income was never recorded. There is no write-off needed — the invoice was simply never income.

This is one reason many small businesses prefer cash-basis accounting: unpaid invoices don't inflate your reported income.

GST/VAT on Bad Debts

If you charged GST or VAT on the invoice and remitted that tax to the government but were never paid, you may be entitled to a bad debt adjustment — effectively reclaiming the tax you paid over that was never collected from the customer.

Rules vary by country:

UK: You can adjust your VAT return after 6 months of non-payment

Australia: GST bad debt adjustments are allowed if the debt is written off

Keep records of the write-off to support any tax adjustment claim.

Keeping Records When Writing Off

Before writing off, document:

The invoice number, amount, and date

The collection attempts made (emails, calls, letters, collection agency)

The reason for write-off (insolvency, long-term non-response, etc.)

The date of write-off

These records serve two purposes: supporting any tax deduction for bad debt, and providing evidence if the client later reappears and tries to claim the debt was never owed.

Bad Debt Provision vs Write-Off

A bad debt provision (or allowance for doubtful accounts) is an estimate of invoices you expect might not be paid, set aside before the specific debt is confirmed as bad. Common in larger businesses with many receivables.

A bad debt write-off is the definitive removal of a specific invoice from your accounts once it's confirmed uncollectible.

For most small businesses, a provision is unnecessary — just write off specific debts when they're confirmed bad.

Practical Steps

Send a final demand letter by post and email

Consider a debt collection agency (they often recover 50–60% of debts for 10–25% commission)

If still unpaid and the amount justifies it, consider small claims court

If all options exhausted, write off the debt in your accounts

Note the write-off date and reason

Claim any GST/VAT bad debt adjustment if eligible

If the client pays later, reverse the write-off and record the income received