A customer who will never pay leaves two separate problems. In the accounts, an asset you have been reporting is worth less than you said, so the loss has to reach the profit and loss account. For VAT, you have already paid HMRC output tax on a sale that brought in nothing. The first is dealt with by your own judgement and the accounting standards; the second has strict conditions set by HMRC. Keeping them apart in the chart of accounts prevents most of the mistakes.
The accounts involved
| Account | Type | What goes in it |
|---|---|---|
| Bad debt expense | Profit and loss (administrative expenses) | Write-offs, increases and decreases in provisions, recoveries |
| Provision for doubtful debts | Balance sheet, credit balance netted against trade debtors | Specific amounts you expect not to collect |
| Input VAT | Balance sheet | VAT reclaimed under bad debt relief |
Some businesses add a separate “bad debts recovered” income account. It is optional; crediting recoveries to the expense account gives a truer net figure for the year.
A specific provision before you give up
Under FRS 102 a trade debtor is reduced when there is objective evidence it will not be collected in full: the customer has entered administration, has stopped responding, or disputes the work and refuses to pay. You do not need to wait until the debt is formally abandoned.
Take Harlow Fit-Out Ltd, which owes £3,600 including £600 VAT and appointed administrators in March. At the March month end:
| Account | Debit | Credit |
|---|---|---|
| Bad debt expense | £3,600 | |
| Provision for doubtful debts | £3,600 |
The invoice stays open in the sales ledger, so the administrators can still be chased and the aged debtors report still shows it. Only the nominal ledger reflects the doubt. Review each provision at every month end and release it if the customer pays.
For corporation tax, a specific provision made in line with the accounting standards is normally deductible. A general provision, such as a flat percentage of all debtors, normally is not. Your accountant will add it back in the tax computation if you use one.
Writing off a bad debt
Write the debt off when there is no realistic prospect of payment: the administrator confirms nothing will be paid to unsecured creditors, the customer has dissolved, or the cost of pursuing it would exceed what you could recover. Record the reason and the evidence with the journal, and have someone other than the person who raised the invoice approve it.
If a provision already exists, the write-off uses it:
| Account | Debit | Credit |
|---|---|---|
| Provision for doubtful debts | £3,600 | |
| Trade debtors (Harlow Fit-Out) | £3,600 |
If there was no provision, debit bad debt expense directly instead. In either case, use your software’s write-off function or a journal with a no-VAT code against the customer account, so the invoice closes in the sales ledger as well as the control account.
Do not issue a credit note to clear a bad debt. A credit note says the sale was reduced or cancelled, and it lowers your output VAT immediately. A bad debt is a sale that happened but was not paid for; the VAT can only be recovered through bad debt relief.
Very small balances left after a customer short-pays are a different matter, covered in small balance write-offs.
Claiming VAT bad debt relief
HMRC’s conditions in VAT Notice 700/18 are, in summary:
- You have already accounted for and paid the output VAT on the sale.
- You have written the debt off in your VAT records and moved it to a separate refunds for bad debts account.
- The price was not more than your customary selling price.
- You have not sold or factored the debt under a legal assignment.
- At least six months have passed since the later of the payment due date and the date of supply.
The claim must be made within four years and six months of that same later date. It goes in box 4 of the return, not as a reduction of box 1. If Harlow’s invoice fell due on 30 January, the debt passes six months unpaid at the end of July, and the claim can first go on the return for the period that includes that date. The journal is:
| Account | Debit | Credit |
|---|---|---|
| Input VAT | £600 | |
| Bad debt expense | £600 |
The net cost of the bad debt is now £3,000, the value of the supply. The refunds for bad debts record must hold, for each debt, the customer’s name, the invoice date and number, the VAT charged, the period in which you originally paid it, the amount written off, the VAT claimed and the period of the claim, plus any payments received. HMRC asks you to keep these for four years from the claim. Businesses on the cash accounting scheme do not need the relief, because they never paid the VAT in the first place. More detail on the evidence is in VAT bad debt relief records.
When the money turns up after all
Administrators sometimes pay a dividend to unsecured creditors months later. Suppose £900 arrives from Harlow’s administrators after you have claimed relief. You must repay part of the VAT you reclaimed, in proportion to the amount received: £600 × £900 ÷ £3,600 = £150, declared in box 1 of the return for the period the money arrives.
| Account | Debit | Credit |
|---|---|---|
| Bank | £900 | |
| Output VAT | £150 | |
| Bad debt expense | £750 |
Also record the receipt in the refunds for bad debts account. If you wrote the debt off but had not yet claimed relief, reduce the claim instead of repaying.
On the face of the accounts
Trade debtors are shown in the balance sheet net of the provision; the provision is not a separate line. The expense sits in administrative expenses. If bad debts are unusually large in a year, your accountant may want to mention them in the notes.
Keeping bad debts rare
Most write-offs start as an invoice nobody chased at thirty days. A weekly credit control routine and a review of the trade debtors account at each month end catch most problems while the customer can still pay. When a debt is worth pursuing formally, debt recovery options sets out the steps before you write anything off.