Periodically, you will need to write off bad debts, i.e., declare certain invoices as non-collectible and remove them from your previously stated income. Consult with your accountant and/or attorney to determine the best method for your business to manage bad debt before you make any changes.
To record a bad debt:
Note: If you are not sure which account to use for bad debts, please consult an accounting professional.
You can also enter a reversing Credit Memo or Journal Entry and link the transaction to the Invoice in Receive Payments.
Receiving a payment from a customer for a debt that was previously written off as being uncollectible creates a credit balance on the customer's account that needs to be adjusted.
Important: There may be tax implications when receiving payment of a bad debt. Consult with your accountant or attorney regarding the tax implications for your situation.
Generally accepted accounting principles (GAAP) recommend using the allowance method to manage bad debt if you are using accrual accounting. Each time you invoice customers, you debit a portion of the income to Bad Debt Expense and credit the same amount to Allowance for Bad Debts. When you write off a bad debt, you credit A/R and debit Allowance For Bad Debts. You would use this method for two reasons:
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When you use cash basis accounting, you do not have bad debt because your customer has not paid you and you have not recorded income from the invoice. However, if you are entering accrual transactions (invoices), then you may want to clear your Accounts Receivable invoices that will not be paid.
This discussion presumes you are using cash basis accounting and cash basis reporting.
As we said above, when you use cash basis accounting, you do not have bad debt because you have not recognized income. However, you may need to clear open invoices showing in your A/R aging reports. You have some options:
What you do not want to do is to enter a credit memo or a journal entry or a discount reversing the invoice. When you link the reversing transaction to the invoice, you are recognizing income that you do not have and an expense you did not incur.
When you have a partially paid invoice, the options above do not work: you cannot void the invoice and you cannot make the invoice pending. But you do have an option: