How to Write off Accounts Receivable?
Accounts receivable is an important component of a business’s working capital management and involves the tracking, collection, and management of payments from customers. It represents the obligation of a customer to pay for goods or services that have been rendered and is typically supported with invoices. As such, it is critical for businesses to actively manage their accounts receivable in order to keep their cash flow healthy.
Accounts Receivable
Accounts receivable, or AR, is a vital part of any business as it is the main source of cash inflow into the company. AR are payments that customers, clients, and other debtors owe to the company. The accounts receivable lifecycle consists of every step within the process of selling until the collection of payments. It starts with a customer making his or her purchase and is completed when the payment is collected.
The first stage of the accounts receivable lifecycle is the invoicing and billing process. This involves creating an invoice for each sale made and sending it to the customer along with the terms. It may include payment due dates or interest rates if overdue payments occur. During this step, businesses generally have policies in place to ensure the accuracy of each invoice issued.
The second step of AR management is following up with customers for unpaid invoices. Companies typically contact customers periodically regarding past due bills to follow up on payment progress, discuss payment plans or options, and inform customers about late fees or other consequences for non-payment. Businesses also send friendly reminders to remind customers about the outstanding amount.
Some companies may work with third-party collections agencies if necessary to collect long-overdue payments from customers who refuse to pay despite repeated communication attempts.
Once a customer pays off their debts, the final step of the accounts receivable lifecycle is officially reached. The company records the payment and posts it into the company’s accounting system. It will automatically remove the outstanding accounts receivable balance.
How to write off accounts receivable
Accounts receivable (AR) become bad debt when they are unable to be collected from customers. This can happen for a variety of reasons, including but not limited to fraud, insolvency of the customer, or failure of the customer to respond to collection efforts. When AR remain outstanding for too long, companies eventually have to write them off as bad debt in order to remove them from the balance sheet.
Writing off accounts receivable as bad debt is a costly endeavor and it is important that businesses take measures beforehand to reduce their risk. Such measures may include more detailed credit checks on new customers as well as monitoring existing customers’ payment arrangements more closely. Additionally, it can be useful for companies to provide their customers with installment plans or other flexible payment options that make it easier for them to pay on time.
The process of writing off accounts receivable as bad debt should be done correctly in order to maintain the accuracy of the financial statements. A write-off must first be approved by management, and then it should be recorded on the company’s balance sheet using appropriate accounting entries.
If there is still a chance that partial or full payment may be received at an upcoming date, those amounts should be recognized in revenue when recovered.
Indicator of Accounts Receivable Write Off
The indicator to write off accounts receivable is an important tool for businesses that helps them to manage their outstanding accounts receivable and cash flow. Additionally, tracking and writing off these bad debts can also be beneficial for tax purposes since claims can be made for deductions related to bad debts expense.
This indicator is typically chosen when a customer has not paid or provided payment in full within the estimated timeframe given by the seller. Once businesses have made this determination, the balance of this account will usually be written off and recorded on the financial statements as “bad debt expense”.
These are some indicators that may require writing off the accounts receivable.
- Delayed or missed payments
- Ignore the reminders sent by the collection team
- Poor credit history from the credit reporting agency
- Low collection rate
- Decrease in revenue or profit
Journal Entry to Write off Accounts Receivable
There are two methods that can be used to account for accounts receivable write-off, it is the allowance for bad debt and direct write-off.
Allowance for Bad Debt
Under allowance for bad debt, the company estimates the amount of bad debt expense right after the credit sale. The company will calculate and record the bad debt expense when making a sale.
The journal entry is debiting bad debt expenses and crediting allowance for bad debt.
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | $$$ | |
| Allowance for Bad Debt | $$$ |
The bad debt expense will be present on the income statement. The allowance for bad debt is the contra account of AR which will reduce the net amount of AR on the balance sheet.
When the actual bad debt happens, the company simply reverses the allowance for bad debt and accounts receivable.
The journal entry is debiting allowance for bad debt and crediting accounts receivable.
| Account | Debit | Credit |
|---|---|---|
| Allowance for Bad Debt | $$$ | |
| Accounts Receivable | $$$ |
Direct Write-Off
Under this method, the company records bad debt only when it really occurs. The company does not make any estimate to predict the future uncollectible accounts receivable. Only the actual bad debt is recorded as an expense on the income statement.
The journal entry is debiting bad debt expenses and crediting accounts receivable.
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | $$$ | |
| Accounts Receivable | $$$ |
Conclusion
Accounts receivable write off are an essential tool in business, as it allows to stay organized and ensure that accounts receivable are being paid on time. The process of accounts receivable write-off involves writing off a customer’s unpaid or uncollectible invoice amount from the record. Through the process of accounts receivables write-off, businesses can keep track of whom has and has not made payments, and maintain good accounting practices. By properly managing and tracking their accounts receivables through accounts receivable write off, companies can more effectively manage their finances and cash flow which will ultimately allow for greater benefits.
