It also goes by bad debts expense, uncollectible accounts expense, credit loss expense under US GAAP and impairment losses on trade receivables under IFRS. It reduces profit, but no cash leaves the business when you record it. The cash was lost earlier, when you delivered goods or services that the customer never paid for.
Allowance method vs direct write-off method
Under the allowance method you estimate losses across all open accounts receivable at each reporting date and adjust the allowance for doubtful accounts, so the expense falls close to the period of the sale. Under the direct write-off method the expense waits until you write off a specific invoice, often months later.
| Feature | Allowance method | Direct write-off method |
|---|---|---|
| When the expense is recorded | At each reporting date, based on expected losses | When a specific invoice is written off |
| Entry for the expense | Debit bad debt expense, credit the allowance | Debit bad debt expense, credit accounts receivable |
| US GAAP and IFRS | Required by ASC 326 and IFRS 9 | Acceptable only where the difference is immaterial |
| US federal income tax | Not used for the deduction | Used, as the specific charge-off method |
ASC 326 tells you to report as credit loss expense the amount needed to adjust the allowance for credit losses to your current estimate (FASB ASU 2016-13). Paragraph 5.5.8 of IFRS 9 does the same for the loss allowance and calls the result an impairment gain or loss.
How to calculate bad debt expense
Start from the allowance you need at the reporting date, usually built from an accounts receivable aging report. Bad debt expense equals that required allowance minus what is left in the allowance after the period's write-offs and recoveries.
Example. A distributor starts the year with an allowance of $30,000 (all figures are illustrative). During the year it writes off $26,000 of invoices and recovers $2,000 it had written off the year before. At year end its aging report supports an allowance of $34,000, so with $30,000 minus $26,000 plus $2,000 = $6,000 left before the adjustment, bad debt expense is $34,000 minus $6,000 = $28,000.
A quicker estimate multiplies credit sales by a historical loss rate, for example $3,200,000 × 0.9% = $28,800. It is a useful check, but ASC 326 and IFRS 9 both measure the allowance at the balance sheet date, and that sets the expense.
How to write off a bad debt
Write off an invoice when you no longer expect to collect it, for example after the customer's insolvency. Under IFRS 9 (paragraph 5.4.4) you reduce the gross receivable when there is no reasonable expectation of recovery, and under ASC 326 write-offs come out of the allowance in the period they are deemed uncollectible.
Under the allowance method the write-off debits the allowance and credits accounts receivable, so profit does not change. First check that the invoice was not paid and left unmatched, and keep the record of reminders, calls and letters.
Bad debts and tax in the US and UK
For US federal income tax, you deduct a business bad debt, in full or in part, only in the year it becomes worthless and only if the amount was included in your gross income (IRS Topic 453). This is the specific charge-off method, so adding to the allowance gives no deduction, and the IRS expects you to show reasonable steps to collect.
In the UK, VAT bad debt relief lets you reclaim the VAT you paid to HMRC on an unpaid invoice. The debt must be unpaid 6 months after the later of the due date and the date of supply, not sold or factored, and written off in your VAT accounts, and you claim within 4 years and 6 months (VAT Notice 700/18). On a £6,000 invoice including VAT at 20%, the relief is £6,000 ÷ 6 = £1,000, claimed in box 4 and repaid if the customer pays later.
How to keep bad debt expense down
- Check customers before you give credit. Look at filed accounts and payment history, and set a limit you review.
- Remind before the due date. A reminder a few days early catches invoices that never reached the person who pays.
- Follow up early and on a schedule. Older debts are less likely to be paid, so call within days of the due date, not weeks.
- Escalate on time. Put the account on hold, send a final demand and decide on an agency or court claim while the customer can still pay.
Sunbay connects to your ERP or accounting system and runs a follow-up sequence on every invoice, from email and SMS reminders before the due date to AI voice calls, interest notes and demand letters. It flags invoices it predicts will be paid late and keeps every reply and payment agreement next to the invoice, which gives you the collection history to show before a write-off. See how automated reminders and escalations work.
Frequently asked questions
Is bad debt expense an operating expense?
Usually, yes. US companies typically include it in selling, general and administrative expenses, because giving credit is part of selling. IAS 1 lists impairment losses under IFRS 9 as a line item in profit or loss, so IFRS reporters often show them on their own line.
Can bad debt expense be negative?
Yes. If expected losses fall, for example because a large overdue invoice is paid, the allowance is reduced and the period shows a reversal of credit loss expense under US GAAP or an impairment gain under IFRS 9.
What is the difference between bad debt expense and the allowance for doubtful accounts?
Bad debt expense is the cost recorded in the income statement for a period. The allowance is the balance sheet account that holds the estimate of uncollectible receivables at a date, and the expense is the amount that moves it to the level it needs to be.
.svg)