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What is Bad Debt?

Bad debt is an amount owed by a customer that a business determines will never be collected. It arises when a customer goes bankrupt, disappears, or refuses to pay. The debt is removed from Accounts Receivable and recorded as a Bad Debt Expense, reducing both revenue and the asset balance.

Every business that sells on credit has some customers who do not pay. The question is when to accept that an invoice is uncollectable. Common signals: the customer is six months overdue, has gone into insolvency, or has broken contact after multiple collection attempts. At that point, holding the debt on the books as an asset is misleading — it overstates what you are owed.

There are two methods. Under direct write-off, you remove the specific invoice when you give up on it. Under the allowance method, you estimate bad debts in advance and hold a reserve (Allowance for Doubtful Accounts). The allowance method is required under IFRS and gives a more accurate picture, but direct write-off is simpler and common in small businesses.

Example

A web design agency has a €5,000 invoice that is 8 months overdue. The client has dissolved the company. The agency writes off the debt: debits Bad Debt Expense €5,000, credits Accounts Receivable €5,000. The invoice is no longer counted as money owed.

Questions

Can I reclaim VAT on a bad debt?

In most EU countries, yes — if the debt is over 6 months old and was originally invoiced with VAT. You reclaim the VAT portion on your next VAT return. The rules vary by country, so check your local tax authority.

What happens if a customer pays after I wrote off the debt?

You reverse the write-off: debit Cash and credit Bad Debt Recovery. The payment is now income, not a collection of the original receivable.

See how Nika handles this

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