Glossary
Bad Debt Write-Off
A bad debt write-off is the accounting step of removing a receivable a business no longer expects to collect from its books and recording it as a loss or expense.
A bad debt write-off happens when a company decides that an invoice, or part of one, is unlikely to be paid. Under accrual accounting, many businesses estimate expected losses in advance with an allowance for doubtful accounts, then charge specific invoices against that allowance when they are written off. Smaller businesses sometimes use the direct write-off method, recording the expense only when a specific account is deemed uncollectible. Your accountant can advise which method fits your reporting needs.
For tax purposes, the rules are different from book accounting. In general, a business on the accrual method that has already reported an invoice as income may be able to deduct a business bad debt once it becomes wholly or partly worthless. A cash-basis business usually cannot deduct an unpaid invoice, because the income was never reported in the first place. These rules have details and exceptions, so creditors should confirm treatment with a tax professional.
An important point for collections is that a write-off is an internal accounting entry, not a legal release. The customer still owes the money unless the creditor signs a release, the debt is discharged in bankruptcy, or the statute of limitations runs. For example, a fictional machine shop, Ridgeway Precision, writes off a $9,300 balance owed by a closed customer. Two years later a collection agency locates the former owner, who personally guaranteed the account, and recovers part of the balance. That recovery is then recorded as income.
The write-off decision matters because it affects reported profit, taxes, and how much effort the business keeps putting into the account. Writing off too early can mean giving up on money that was still collectible. Writing off too late overstates assets. Many creditors place accounts with a collection agency before or at the time of write-off, so recovery efforts continue even after the balance leaves the active ledger.
Example
Ridgeway Precision writes off a $9,300 unpaid balance. Two years later, its collection agency recovers $5,000 from the personal guarantor, and the company records that amount as recovered income.