Bad Debt

Bad debt can quietly erode cash flow, distort profit figures and create unexpected tax and GST consequences. This practical guide explains what a bad debt (unrecoverable receivable) is, when a debt becomes unrecoverable, how to treat it in your accounts and tax returns, GST adjustment steps, and straightforward procedures to document, write off and—if needed—recover amounts.

What is a bad debt?

A bad debt (also described as an uncollectible debt or unrecoverable receivable) is an amount you have included as assessable income—usually an issued invoice or recorded sale—that you cannot reasonably recover. Common scenarios include a customer becoming insolvent or bankrupt and unable to pay outstanding invoices, a debtor who cannot be contacted and traceable records run out, or a situation where a court judgment is obtained but the debtor has no assets to satisfy the judgment.

A bad debt is an unrecoverable receivable you can write off from income after taking reasonable recovery steps and holding evidence the amount is unlikely to be collected. When you write off a bad debt you may be eligible for a tax deduction under ATO rules and must consider GST adjustments if GST was previously reported. See ATO guidance on deductions for unrecoverable income.

How bad debt happens — common scenarios

Bad debts typically arise from everyday business risks. Typical scenarios include:

• Business insolvency or bankruptcy — trading counterparties enter administration and stop paying.
• Long-overdue accounts where reminders, demand letters and collection attempts fail.
• Dishonoured or bounced cheques where the payer cannot make good the payment.
• Disputed work where enforcement fails or the debtor lacks assets to satisfy a judgment.
• Untraceable debtors — insufficient contact details and returned mail indicate likely loss.

If legal action is required, AFSA and ASIC resources outline steps and timelines.

Accounting treatment: write-off vs doubtful debt provision

Accounting choices affect profit, balance sheet accuracy and tax timing. The two common approaches are a specific write-off and a doubtful debt provision (allowance for expected credit losses / allowance for doubtful debts).

When to write off a debt

Write off a debt when it is confirmed unrecoverable. Typical indicators include:

• Debtor is formally bankrupt/insolvent (evidence via AFSA).
• Court judgment obtained but enforcement returns nil.
• Exhausted recovery steps and debtor cannot be traced.
• Statute of limitations for recovery has expired (check relevant limitations).

A write-off recognises the loss as an expense and removes the receivable from the balance sheet.

How to record a write-off — sample journal entries

Sample journal entries when writing off a $1,000 unpaid invoice (exclusive of GST):

Original sale (when invoiced)

• Dr Accounts Receivable $1,500
• Cr Sales Revenue $1,000
• Cr GST Collected $100

Writing off the debt (debt confirmed unrecoverable)

• Dr Bad Debt Expense $1,000
• Dr GST Collected (or GST adjustment account) $100
• Cr Accounts Receivable $1,500

If you used an allowance method previously, the write-off reverses the allowance:

• Dr Allowance for Doubtful Debts $1,500
• Cr Accounts Receivable $1,500

Worked example

What is a doubtful debt provision (allowance for expected credit losses)?

A doubtful debt provision is a balance sheet allowance for receivables you expect may not be recovered. It uses an expected-loss model and is typically updated each reporting period:

• To recognise the provision:
  • Dr Bad Debt Expense (P&L)
  • Cr Allowance for Doubtful Debts (Balance Sheet)
• To write off a specific account later:
  • Dr Allowance for Doubtful Debts
  • Cr Accounts Receivable

A provision is an estimate (affects profit now but not cash), while a write-off removes a specific receivable once unrecoverable. See also best practice entries in write-off.

Tax treatment: claiming a bad debt deduction

The ATO allows deductions for bad debts that meet strict conditions. Correct timing and documentation are essential.

ATO conditions for claiming a bad debt

You can claim a deduction for a bad debt if:

• The amount was previously included in your assessable income.
• The debt is genuinely incurred and is bad and doubtful (unlikely to be collected).
• You have taken reasonable steps to recover the debt.
• You retain sufficient records to support the claim.

See ATO detail on deductions for unrecoverable income.

Evidence you must keep

The ATO expects contemporaneous evidence of recovery attempts and proof the debt is unrecoverable:

• Original invoice(s) and terms of sale.
• Statements of account and follow-up correspondence.
• Demand letters and records of phone calls (dates, content).
• Collection agency reports (if used).
• Insolvency/Bankruptcy notices (AFSA or court documents).
• Court judgments and enforcement activity.
• Proof of returned mail or inability to trace debtor.

Keep these records before claiming a deduction; inadequate evidence is a common cause of disallowed claims.

Timing of the deduction (accrual vs cash basis taxpayers)

Accrual (invoice) taxpayers claim the deduction when the debt becomes bad (when you write it off), even if the invoice was recognised earlier. Cash basis taxpayers can only deduct amounts actually received and then written off—if you never received the income, there may be no deduction because you never included it in income.

Always match the deduction to the tax treatment of the original income recognition. For specifics, consult your tax agent.

GST implications and adjustments

If you reported GST on a taxable supply you later cannot collect, you may be entitled to adjust the GST previously reported. On writing off the debt, you normally adjust the GST on your next (or a later) Business Activity Statement (BAS) once the debt is bad and you have reasonable evidence. The adjustment reduces the GST liability previously reported; record it as a GST adjustment in the BAS for the relevant period.

For the $1,000 invoice example: GST originally reported was $100. On write-off, claim a GST adjustment of $100, reducing net GST payable for the BAS period when the debt is written off.

See ATO GST guidance for GST adjustment guidance.

Recoveries after a write-off: tax and accounting consequences

If you recover part or all of a debt after writing it off:

Accounting: reverse the write-off or record recovery income. If you recover $1,200 of the $1,000 written off:

• Dr Cash $1,320
• Cr Bad Debt Recovery (or Other Income) $1,200
• Cr GST Collected $120 (if GST applies)

Tax: recovered amounts are assessable income in the period of recovery to the extent you previously claimed a deduction.

GST: if you previously adjusted GST downward, you must account for GST on recovered amounts in the BAS for the recovery period.

Record recoveries clearly to avoid misstating income.

Practical step-by-step: how to write off a bad debt (checklist)

Follow a clear internal process before writing off and claiming a deduction:

1. Confirm the debt was included in income.
2. Take reasonable recovery steps (keep records):
   • Send at least two reminders and one formal demand letter.
   • Make phone call attempts and log details.
   • Consider a lawyer's letter of demand or use a collection agency.
3. Obtain proof of debtor insolvency where relevant (AFSA, court documents).
4. Seek internal approvals:
   • Prepare a write-off request showing invoice history, recovery steps and recommended accounting entry.
   • Require sign-off by finance manager and CFO or authorised delegate.
5. Make accounting entries:
   • If you had an allowance, reverse it and write off AR.
   • If no allowance, record bad debt expense and remove AR.
6. GST and BAS:
   • Prepare a GST adjustment for BAS if GST was previously reported.
7. Taxation:
   • Ensure documentation to support ATO deduction (retain for at least 5 years per record-keeping rules).
8. Post-write-off:
   • If recovery occurs later, record it as income and account for GST.

Sample demand-letter wording

"Final Notice: Invoice INV-123 for $1,500 (incl. GST) remains outstanding and is due immediately. If payment is not received by [date], we will commence recovery action including referral to a debt collector or legal proceedings."

Minimum documentation checklist

• Invoice, contract or sale documentation
• Statement of account
• Demand letters and correspondence log
• Evidence of attempts to contact and locate debtor
• Insolvency/AFSA or court documents (if applicable)
• Internal approval for write-off

Where cashflow is a concern, consider working capital options such as invoice finance or a line of credit while managing receivables.

Interaction with credit reporting and debt recovery options

When recovery attempts fail, escalate appropriately:

• Credit reporting: list the default with authorised credit reporting bodies (ensure compliance and consider the debtor's rights).
• Collection agencies: engage a licensed collector and retain their reports as evidence.
• Small claims or civil court: commence proceedings—keep proof of debt, delivery and demand steps to support your case.
• Enforcement: if you obtain judgment, enforcement options include garnishee, writ for levy or bankruptcy application; check ASIC/AFSA processes.
• Insolvency: if the debtor enters formal insolvency, lodge a proof of debt with the administrator or trustee; this affects recoverability and timing.

Consider credit policy improvements and risk management processes for future recovery prevention.

Common mistakes and pitfalls to avoid

• Claiming a deduction without sufficient evidence — keep contemporaneous records.
• Writing off debts too early — ensure you have taken reasonable recovery steps.
• Failing to adjust GST when required or incorrectly adjusting BAS periods.
• Confusing disputed debts with bad debts — a dispute alone may not qualify for a deduction.
• Not getting internal approvals or failing to document the decision-making process.
• Overlooking recoveries — recovered amounts must be treated as income.

Use clear planning and provisioning best practices for handling doubtful debts.

FAQ

Key takeaways

Bad debts are a normal business risk but, left unmanaged, they damage cash flow and distort results. Use a documented recovery process, gather clear contemporaneous evidence, follow appropriate accounting entries for provisions and write-offs, make GST adjustments when required, and record any later recoveries correctly. When in doubt, check the ATO's rules and seek advice from your accountant, tax agent or legal advisor to ensure compliance and correct tax treatment.

Further reading

• ATO — Deductions for unrecoverable income (bad debts)
• ATO — GST guidelines and BAS adjustments
• AFSA — bankruptcy and insolvency information
• ASIC — insolvency and enforcement information

This article is general information only and is not legal, tax or financial advice.