Businesses accumulate debt in a variety of ways. One way is to extend credit to another party or business that remains unpaid and uncollectable. When this situation occurs, the debt is considered a “bad debt” and it is then classified as a business expense. This situation may also arise when a business sells a product or service to another party or business that the customer does not pay for. The debt may not be able to be recovered due to bankruptcy or your own business practice.
The first step in writing off bad debt is determined by whether your business utilizes a cash accounting method or the accrual accounting method. The former is a process in which you record income as soon as you receive payment and deduct expenses when you pay a bill. This is the most common accounting method. The latter method is used when you record the income as soon as you make a sale, even if you have not yet been paid for the good or service.
To write off the bad debt under a cash accounting method, you must void the invoice related to the debt so that it is not computed as income. Complete this step by going to the Customer Center, locating the relevant invoice and clicking on the button entitled “Void.” To remember why you voided the transaction, you can create a note in the memo field. If you handle many customers and would like to indicate the sour transaction, you can add a note beside the customer’s name in the Customer Center.
To write off bad debt under the accrual accounting method, you must utilize an allowance for these types of debts. This process requires you to assess the bad debts that you might experience through the course of your business. This entails creating an account for the Allowance for Bad Debts and a Bad Debt Expense as part of your Chart of Accounts. Go to Chart of Accounts to add or edit accounts. To complete this method, input the amount of bad debt that you expect to acquire and create a debit for the Bad Debt Expense and a credit for the Allowance for Bad Debts account. Once you determine that a debt is not collectible, debit the Allowance for Bad Debts and credit Accounts Receivable. These journal entries are available under the selection for Banking, then More, then Journal Entry.