Bad debt: writing off an invoice you'll never collect

Every set of books eventually holds an invoice that is never going to be paid. The customer stopped answering months ago, then the emails bounced, then you found the bankruptcy notice. On your balance sheet that invoice still sits in accounts receivable, counted as money you own. It is not money. Leaving it there quietly inflates what you are worth and overstates the profit you booked when you sent it. Writing it off is how you tell the truth about it.

Bad debt is a receivable — an invoice you earned and sent — that you have concluded you will never collect. Recognizing it is not an admission that your bookkeeping failed. It is the ordinary, correct way to move a dead asset off your books and record the loss in the period you finally know it is real.

When a receivable turns into bad debt

There is no single day an invoice officially dies, but there are clear signals. You write off a receivable when the evidence says collection is no longer reasonable, not when it is merely late. A 45-day-old invoice is a collections problem; a 200-day-old invoice from a customer who has gone dark is usually a loss you have not booked yet.

The common triggers look like this:

• You have exhausted collections — reminders, calls, a credit hold, and a formal demand — with no result.
• The customer has filed for bankruptcy, and you are an unsecured creditor unlikely to see meaningful recovery.
• The business has shut down, the contact is unreachable, and there is no successor to bill.
• The invoice has aged well past your terms — typically 90 to 180 days — with no payment and no credible promise to pay.
• The cost of chasing the balance now exceeds the balance itself.

Two ways to record it

There are two accepted methods. The direct write-off method is the simpler one: you wait until a specific invoice is clearly uncollectible, then remove exactly that invoice. Most small companies use it because it is easy and matches how they actually think. Its weakness is timing — the loss lands whenever the invoice dies, which may be a quarter or two after the sale that created it.

The allowance method is what GAAP (Generally Accepted Accounting Principles, the U.S. rulebook) prefers, because it matches the expected loss to the same period as the sale. You estimate, ahead of time, how much of your total receivables will go bad and set up an allowance for doubtful accounts — a contra-asset that offsets AR. You size that allowance one of two ways: as a flat percentage of total AR, or, more precisely, by aging — applying a higher risk percentage to the older buckets, since a 90-day invoice is far likelier to fail than a current one.

The journal entry and what it does to your numbers

Under the direct method the entry is one line each way: you debit bad debt expense and credit accounts receivable for the dead invoice. The debit is an operating expense that lowers net income on your profit-and-loss statement; the credit removes the invoice from AR on your balance sheet. Your reported profit and your assets both fall by the same amount, which is the point — both were overstated while the dead invoice lingered.

Under the allowance method there are two moments. When you estimate, you debit bad debt expense and credit the allowance — that is where the P&L hit happens. Later, when a specific invoice actually dies, you debit the allowance and credit accounts receivable. That second entry touches only the balance sheet; it does not hit your P&L again, because you already recorded the expense when you built the reserve.

A worked example

Say you run on the direct write-off method. In March you invoiced Northgate Interiors $8,000 for a completed project on net-30 terms. You recognized $8,000 of revenue then, and it has sat in AR ever since. By September the invoice is 150 days past due; you have called, emailed, placed the account on credit hold, and sent a demand letter. In October you learn Northgate has closed and filed for bankruptcy with no assets left to distribute.

You write it off. The entry: debit bad debt expense $8,000, credit accounts receivable $8,000. Your AR drops by $8,000, so the balance sheet stops claiming money that will not arrive. Your October P&L carries an $8,000 expense, cutting net income by that amount. The revenue you booked back in March stays put — you earned it and reported it honestly at the time. The write-off simply corrects the asset now that you know its true value is zero.

The tax rule, and why a write-off is not surrender

The accounting entry and the tax deduction are not the same event. The IRS lets you deduct a business bad debt only when it is actually worthless — you must be able to show the debt has no reasonable chance of recovery, not merely that it is old. And here is the rule that trips up small businesses: if you file taxes on the cash basis, you cannot deduct an unpaid invoice at all, because you never reported that $8,000 as income in the first place. There is no loss to deduct when the money was never counted. Only accrual-basis taxpayers, who recognized the revenue up front, get the bad-debt deduction.

Finally, writing off an invoice is a bookkeeping decision, not a legal release. You have not forgiven the debt or told the customer it is settled — you have only stopped counting it as an asset. You can still hand it to a collection agency, pursue it in small-claims court, or accept a late payment if the customer resurfaces. If you do collect later, you reverse the write-off and record the cash. Take the invoice off your books once it is clearly dead; keep the right to chase it for as long as chasing is worth the effort.