What is an Invoice Write-Off?

An invoice write-off is an accounting procedure used when a business determines a customer’s invoice is uncollectible. The process involves removing the unpaid invoice from the company’s accounts receivable and recognizing it as a bad debt expense.

While the terms “invoice write-off” and “bad debt expense” are closely related, they refer to different aspects of accounting for uncollectible receivables:

An invoice write-off is the action taken to remove a specific uncollectible invoice from accounts receivable. It involves crediting accounts receivable to reduce its balance and debiting the bad debt expense account to record the loss.
The bad debt expense account represents the cost to the business of extending credit to customers who ultimately do not pay. It is recorded on the income statement and reflects the total estimated uncollectible accounts for a given period.

Write-offs are also different from write-downs. In the latter scenario, a business still expects to receive partial payment for the invoice, but at a reduced amount. On the other hand, a write-off assumes that there is no possibility of collecting any payment on the invoice.

Synonyms

Invoice charge-off
Debt cancellation

The Purpose of Write-offs

There are four main reasons invoice write-offs are a critical part of financial management:

Reducing losses from bad debt
Better cash flow forecasting
Cleaning up accounts receivable
Decreasing tax liability

Let’s dive into each reason and how invoice write-offs can help in these areas:

Reducing losses from bad debt

Write-offs help you minimize losses from outstanding invoices that won’t be paid. By recognizing a bad debt expense, you are acknowledging that the invoice will not be paid and adjusting your financial records to reflect your true financial position.

Continuing to pursue uncollectible debts can be costly and time-consuming. Writing these invoices off allows you to allocate resources more efficiently, focusing on profitable activities rather than futile collection efforts.

In some cases, writing off a debt can also help you preserve a positive relationship with a client who is unable to pay due to unforeseen circumstances. In the future, they might refer customers to you, share positive feedback that lands you new customers, or do business with you again.

Better cash flow forecasting

By removing uncollectible accounts from your accounts receivable, you’re making sure your financial statements accurately reflect the true value of your business income. Come time to make revenue projections, this prevents you from overestimating your expected cash inflows.

By extension, accurate cash flow forecasts (facilitated by timely write-offs) enable your management team to make informed budgeting, resource allocation, and strategic planning decisions.

On top of that, regularly writing off bad debts can highlight patterns that highlight underlying issues in your company’s credit policies, how you choose your customers, and how efficient your AR collections process is.

Cleaning up accounts receivable

Part of complying with accounting standards like Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) is recognizing and recording your business write-offs.

Since they directly impact your total reported income and your performance of the invoice’s line items affect revenue recognition, your accounts receivable invoices are a huge component of this.

Decreasing tax liability

When you recognize an unpaid invoice as a bad debt expense, it lowers your net income, thereby decreasing your tax liability. The IRS allows you to write off bad debts so you aren’t paying taxes on income you never received.

By reducing your tax liability, you can reinvest those savings back into your business or use them to pay off your own debts and expenses. But without a proper write-off process, you might not be allowed to claim these expenses in an audit.

Reasons to Write Off Unpaid Invoices

An invoice is generally written off only when it’s considered “uncollectible.” This means you pursued the collection process and have proof there are no hopes of receiving payment. If you’re simply dealing with an overdue invoice, you might not have exhausted all other options to collect the payment, or the expense could still be considered collectible.

Here are some reasons why you might have to write off customer invoices:

Customer bankruptcy or insolvency

If your customer or client has recently declared bankruptcy or insolvency, you can reasonably assume they won’t pay their outstanding balance. This is because bankruptcy or insolvency proceedings often include a debt repayment plan that doesn’t involve paying off all outstanding debts, especially those owed to unsecured creditors like vendors and suppliers.

Customer disputes or disagreements

Sometimes, it’s better to write off an invoice than to continue pursuing payment from a customer who is disputing or disagreeing with the amount they owe. In this case, it’s important to consider the potential costs of legal action against the customer and weigh them against the amount owed.

Persistent non-payment

If a customer simply doesn’t pay in spite of collection efforts (e.g., phone calls, emails, letters), it might be time to consider writing off the invoice. If this is your reason, it’s important to document all your attempts to collect payment in case of an audit.

Errors in billing or invoicing

There are several mistakes that could invalidate an invoice:

Pricing errors
Duplicate invoices
Incorrect discounts applied to the invoice
Data entry errors like entering a wrong quantity or price into the system

In these cases, the invoice is uncollectible because it wasn’t correctly billed to the customer. You might issue a new invoice with the corrections or simply write off the uncollectible invoice.

Outdated or obsolete products or services

Sometimes, the value of the products or services invoiced to a customer decreases significantly by the time the invoice is due. This could be due to market changes, technological advancements, or simply the expiration of a product’s lifespan. In those cases, your policy might allow writing off the invoice rather than trying to collect on an outdated or obsolete product.

How to Properly Write Off an Invoice

If you don’t prepare the bad debt expense account and write off the invoice correctly, the IRS might not accept it as a legitimate deduction. Not to mention, having a messy write-off process will only serve to make things more complicated when you’re trying to communicate your financial position to creditors, lenders, investors, and auditors.

You need to gather evidence, documents, and records to support the statement that the invoice is a bad debt. And you’ll need to create specific policies for how long you’ll wait before writing off an invoice and how you’ll handle different types of bad debts.

Check your accounts receivable aging report

The first thing you’ll do is identify the invoice you’re going to write off. To do that, look at your AR aging report — the document within your accounting system that tracks all the money your customers owe you, and how long they’ve owed it for.

Most companies use an aging schedule that categorizes invoices based on how many months they’ve been overdue (e.g., 30, 60, 90, 120 days). Invoices exceeding 90 to 120 days past due are the ones you should scrutinize for potential write-offs, especially if collection efforts have been unsuccessful thus far.

It goes beyond aging, though. You have to look at other factors, like situations that render an invoice uncollectible (like those mentioned above). You also have to consider which accounting principles you’re using.

For instance, the direct write-off method requires that bad debts be recognized when they become certain. It involves charging the amount of an invoice to the bad debt expense account when it’s clear that the invoice will not be paid.

Create the bad debt expense account

Adding a bad debt expense account to your chart of accounts is crucial for setting up specific policies and procedures, as well as tracking the financial impact of bad debts. This is simple to do in your accounting software.

On the income statement, it’s reported as an operating expense. On the balance sheet, it’s a contra-asset account that affects the accounts receivable section through the allowance for doubtful accounts.

Prepare the bad debt expense item

When you account for bad debts like invoice write-offs, you can either use the allowance method or the direct write-off method. The one you use influences financial reporting.

The allowance method requires you to estimate uncollectible accounts and record bad debt expenses in the same period as the related sales, using the matching principle. This method is generally preferred under GAAP.
The direct write-off method records bad debt expense only when specific accounts are deemed uncollectible. However, this method can result in misstating income between reporting periods if the bad debt is recognized in a different period from the related sales.

Now, to record it in your books, create an item called bad debt expense, choose one of the above methods to classify it, and calculate the amount of the expense.

Let’s say you have an unpaid invoice that amounts to $1,000 from someone who you’ve tried to collect from multiple times but has not paid. You’ve tried offering a payment plan, sent reminders and even tried to contact them by phone, but with no success.

You’d debit bad debts and credit your accounts receivable account for the full amount — $1,000. As soon as you do this, your income statement will show a $1,000 decrease in revenue, and your balance sheet will see a corresponding $1,000 increase in bad debts.

Create a credit memo, including the write-off amount

A credit memo is a document that notifies a customer of a credit being issued to their account. It is used when a customer has overpaid, returned items, or when an adjustment needs to be made on their account. In the case of invoice write-offs, they’ll get a credit memo for the entire invoice amount.

Close the invoice by applying a credit memo

This is an important step because it’s part of the formal documentation that justifies and proves why you’ve decided to write off the invoice. Make sure to match the credit memo to the invoice in your accounting software (you can include the original invoice reference number) and mark it as closed.

Verify the transaction on your balance sheet and P&L report

You want to make sure the paper trail is complete and that you can easily track the write-off in your financial statements. Verify that the bad debt expense has been recorded correctly on your balance sheet and P&L (profit and loss) report and that everything adds up correctly.

Best Practices for Effective Write-Off Procedures

Again, properly carrying out this process is the most important factor. You need a repeatable process and straightforward policies so that some of your team members don’t accidentally write off invoices too early or use a different procedure than the rest of the team.

Regularly review accounts receivable aging.

Monitor your receivables every couple of weeks, and set up notifications for invoices that reach above that 90-to-120-day threshold. Early identification allows for timely collection efforts or decisions to write off debts when necessary.

Establish clear credit policies.

Define the criteria for extending credit to customers and set straightforward terms for payment. For example, you might offer net 30 payment terms or ask for a deposit upfront to minimize bad debts from unpaid invoices.

Document collection efforts in detail.

Maintain thorough records of all your attempts to collect outstanding debts. Saving revenue collection efforts on the customer account in your CRM and noting communication touchpoints will prove the debt is uncollectible.

Consult with an accounting professional.

While this article is a solid starting resource, proper bookkeeping still requires advice from accountants or financial advisors to ensure compliance with accounting standards and tax regulations when writing off bad debts.

Prioritize customer relationships.

Reach out to customers with past-due balances and navigate communication efforts with tact. Alongside clear policies, being proactive in addressing slow-paying customers prevents disputes, reduces bad debts, and improves relationships with them over time.

Invoice Write-Off