Glossary · Collections
Bad debt
A bad debt is an amount owed to you that you no longer expect to collect, and that is written off as a loss.
A receivable becomes a bad debt when collecting it is no longer realistic: the customer is insolvent, has disappeared, or the cost of pursuing it outweighs the amount. It is removed from receivables and recorded as an expense.
Bad debts have tax consequences. In the US, a business using accrual accounting can generally deduct a business bad debt once it becomes worthless; a cash-basis business can’t, because the unpaid income was never counted. In the UK, VAT paid on an invoice that turns bad can be reclaimed through bad debt relief after six months.
Writing a debt off in the books doesn’t mean giving up the legal claim. If the customer later pays, the recovery is booked as income.
Example
A client owing £6,000 enters liquidation and the liquidator expects to pay unsecured creditors nothing. The supplier writes the £6,000 off as a bad debt and claims back the VAT through bad debt relief.