How to write off an irrecoverable debt

Step by step

1. Confirm the debt is irrecoverable. Establish that the customer will not pay, for example because the business has stopped trading.
2. Debit irrecoverable debts. Debit the irrecoverable debts (expense) account with the amount owed.
3. Credit the customer's account. Credit the trade receivable (the customer's account) to remove the debt.
4. Charge it to the income statement. Include irrecoverable debts as an expense in the income statement.
5. Reduce trade receivables. The statement of financial position now shows a lower, more realistic trade receivables figure.

Worked example

A customer owes RM400 and cannot pay. Debit irrecoverable debts RM400 and credit the customer RM400.

Understanding the method

A trade receivable (money a customer owes) is an asset because the business expects to collect it. If the customer becomes insolvent or disappears, that asset has no value.

Leaving it in the accounts would overstate both assets and profit. This follows the prudence concept: do not overstate assets or profit.

Writing off the debt removes the asset and records the loss as an expense. No cash moves. The business is simply admitting that money it expected will not arrive.

The original sale stays as revenue. The loss is an expense, not a reduction of sales.

The entry debits irrecoverable debts (also called bad debts) and credits the customer's account in the sales ledger. If you are writing in the sales ledger control account, credit that instead.

The debit lowers profit. The credit lowers receivables.

Sometimes only part of a debt is irrecoverable. Here is an example. A customer owes RM2,000 and becomes insolvent.

The administrator pays 30 sen in the ringgit, which is RM600, and says nothing more will follow. The RM600 is a normal cash receipt, so the customer's balance falls to RM1,400. Debit irrecoverable debts RM1,400 and credit the customer RM1,400.

Suppose that eighteen months later the customer sends RM400 as a gesture of goodwill. The debt was already removed, so you do not post this to the customer's account.

Debit cash RM400 and credit irrecoverable debts recovered RM400. It appears as income in the new period.

A write-off is a specific debt that is known to be hopeless. A provision for doubtful debts is an estimate against balances that still exist and may yet pay. Only the change in the provision affects profit.

To check, the customer's account should show nil for the written-off portion. Profit should fall by exactly the amount that receivables fall.

Common mistakes include reducing sales instead of raising an expense, which understates both revenue and expenses. Another is crediting a recovered debt back to the customer instead of recording it as income. Another is writing off the full balance when part has been paid. The loss belongs to the year the debt became irrecoverable, not the year of the sale.

If write-offs, recoveries and provisions blur together in your answers, one of our teachers can separate them for you with worked examples from past papers. Book a trial class

Related skills

• How to prepare a sales ledger control account
• How to prepare an income statement for a sole trader

The methods here are standard accounting practice, with original figures. For your exam board's exact requirements, see exam boards and Sources.