Written byA bad debt is an amount owed to your business, usually an unpaid invoice already counted as income, that you cannot recover despite reasonable efforts and so write off.
Also known as: uncollectible debt, unrecoverable receivable, irrecoverable debt
Key points
- Typical causes: a customer goes into liquidation or bankruptcy, a debtor cannot be traced, or a court judgment cannot be enforced.
- The ATO allows a deduction if the amount was included in assessable income, the debt is genuinely bad and you took reasonable recovery steps.
- If you reported GST on the sale, you can adjust it on the BAS for the period in which you write the debt off.
- Any amount recovered later is assessable income in the period you receive it, and GST must be accounted for again on the recovered amount.
When a debt becomes bad
A debt is bad, rather than just late, once you have taken reasonable recovery steps and hold evidence that it is unlikely to be collected. The usual indicators are a formal insolvency or bankruptcy notice for the debtor, a court judgment that enforcement cannot satisfy, a debtor who cannot be traced after reminders and demand letters, or a limitation period that has expired.
A dispute on its own does not make a debt bad, and writing off too early is a common cause of disallowed claims. Keep the original invoices, statements of account, demand letters, call logs, any collections agency reports and insolvency or court documents, generally for at least five years.
Accounting treatment: write-off or provision
There are two ways to deal with doubtful receivables. A specific write-off recognises the loss as an expense and removes the receivable from the balance sheet once the debt is confirmed unrecoverable. A doubtful debt provision, also called an allowance for expected credit losses, is a balance-sheet estimate of receivables you expect may not be collected, updated each reporting period.
A provision affects profit now without affecting cash; a write-off removes a specific receivable. If you already carry a provision, the later write-off is taken against it rather than hitting profit a second time.
Tax and GST treatment
The ATO allows a deduction for a bad debt only if the amount was previously included in your assessable income, the debt is genuinely bad, you have taken reasonable steps to recover it and you can support the claim with records. Businesses that account on an accruals basis claim the deduction in the year they write the debt off. Cash-basis taxpayers never included the unpaid invoice in income, so there is usually no deduction to claim.
If you reported GST on the sale, you adjust the GST on the BAS for the period in which the debt is written off, reducing the GST payable. Amounts recovered later are assessable income, and you account for GST on them in the BAS for the recovery period. Check the ATO's guidance or your accountant for your circumstances.
Example
A business invoices a customer $5,500, being $5,000 plus $500 GST, and reports the GST on its next BAS. Months later the customer stops answering, two reminders and a formal demand go unanswered, and a search shows the customer's company has gone into liquidation. The business writes off the $5,000 as a bad debt expense, claims the deduction in that year and adjusts the $500 of GST on the BAS for the write-off period. If the liquidator later pays a dividend of $1,320, the $1,200 net of GST is assessable income when received and the $120 of GST is accounted for again on that period's BAS.
Not to be confused with
- Write-off
- a write-off is the accounting entry that removes an unrecoverable amount from the books; a bad debt is the unpaid customer debt that gets written off
- Non-performing loan (NPL)
- a non-performing loan is a lender's classification for a loan in serious arrears; a bad debt is a trade receivable that has become unrecoverable
Frequently asked questions
When can I write off a debt as bad?
Once you have taken reasonable steps to recover it, such as reminders, a formal demand and collection or legal action where that makes sense, and you hold evidence that it is unlikely to be paid. Debtor bankruptcy or liquidation, an untraceable debtor or an unenforceable judgment are the usual triggers. There is no fixed waiting period.
Can I claim a tax deduction for a bad debt?
Generally yes, if the amount was previously included in your assessable income, the debt is genuinely bad, you have taken reasonable recovery steps and you have records to support the claim. Accruals-basis businesses claim in the year of the write-off. Cash-basis businesses usually cannot claim because the income was never returned.
Do I need to adjust GST when a customer does not pay?
If you reported GST on the sale, yes. When you write the debt off you adjust the GST on the BAS for that period, which reduces the GST you owe. If the customer later pays some or all of the debt, you account for GST on the recovered amount in the BAS for the recovery period.
What evidence does the ATO want for a bad debt?
Contemporaneous records that show the debt existed and that you tried to recover it: the original invoice and terms, statements of account, demand letters and call logs, collection agency reports, court judgments and any bankruptcy or insolvency notices. Inadequate evidence is a common reason claims are disallowed.
What happens if I recover a debt I already wrote off?
Treat it as income. The recovered amount is assessable in the period you receive it, to the extent you claimed a deduction, and if you previously adjusted the GST you account for GST on the recovery in that period's BAS. Record it clearly so income is not misstated.
Related terms
Write-off
A write-off is an accounting entry that removes an asset or unpaid customer invoice from the books because it no longer has recoverable value, recording the loss against profit.
Read definitionReceivables
Receivables are amounts owed to your business, mainly by customers for goods or services supplied on credit, recorded as assets on the balance sheet until they are collected.
Read definitionCollections
Collections is the recovery process a lender, creditor or business runs when payments fall overdue: reminders, calls, payment plans and hardship offers, then referral to agencies or legal action.
Read definitionLiquidation
Liquidation is the process of winding up a company: a liquidator takes control, sells its assets, pays creditors in a set order of priority and the company is deregistered.
Read definitionBankruptcy
Bankruptcy is a legal status for an individual who cannot pay their debts, under which a trustee takes control of their affairs and deals with creditors on their behalf.
Read definitionNon-performing loan (NPL)
A non-performing loan (NPL) is a loan where the borrower is not meeting payments and the lender judges full repayment doubtful, commonly once payments are 90 days past due.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.