Managing bad debt is a crucial part of running any business. When a customer fails to pay their dues despite numerous attempts, it’s important to remove that debt from your financial statements to maintain accurate records. In this guide, we’ll show you how to write off bad debt in Xero using the Direct Write-Off Method, ensuring your accounts are accurate and up to date.
How To Write Off Bad Debt In Xero?
When a debt owed to a company is unlikely to be collected and therefore, needs to be removed from the company’s financial statements.
Usually this is done when it becomes clear that the debtor is unable or unwilling to pay, despite many efforts to collect the debt or that the cost of recovery is too high.
Step 1: Identify The Debt
The first step in writing off bad debt in Xero is to identify the debt. During your review of accounts receivable you consider the likelihood of payment based on previous attempts to secure a satisfactory payment.
Step 2: Use The Direct Write-Off Method in Xero
Account for the bad debt using Direct Write-Off Method by directly removing the uncollectable debt from the accounts. This method is straightforward but does not comply with the matching principle in accrual accounting. N.B Deleting/Voiding invoices should be avoided unless in a few certain circumstances – see below.
Step 3. Create a Bad Debt code in Xero
Before writing off any debt, you need to set up a Bad Debt code in Xero.
- Go to Accounting > Chart of Accounts.
- Select + Account.
- Set the following:
- Type: Expense
- Code: Choose the next available free number
- Name: Bad Debt
- Description: Accounts receivable not collected
- Tax: 20% (VAT on Expenses), if applicable
- Save the new account.
Step 4: Write Off the Debt
Once you’ve set up the Bad Debt code, you can write off the uncollectible invoice:
- Go to Business > Invoices > Awaiting Payment.
- Select the invoice you want to write off.
- Click the three dots in the top right corner and choose Create and Apply Credit.
- Change the account to Bad Debt, ensuring the original tax rates remain as they were on the invoice.
- Click Approve.
This process adjusts the sales ledger, keeps your records accurate, and allows you to reclaim any tax previously paid on the uncollectable debt.
N.B. Voiding invoices can be done if not sent out to a client & no vat returns have been prepared and submitted.
Need Help with Bad Debt or Xero?
If you’re struggling to manage bad debt or need guidance on using Xero more effectively, our team at Ascentis is here to help. Contact us today for expert advice tailored to your business.