How to write off an invoice

There are several reasons why you may want to write off an invoice. Perhaps your customer has gone bankrupt, and is no longer able to pay the remaining balance, or the invoice was paid and later refunded. This article will take you through the steps to write off an invoice in Wave.

Follow the method below to write off an unpaid invoice, or the remaining balance of an invoice which has only been partially paid.

Accounting for bad debt with the direct write-off method

The direct write-off method accounts for bad debt when an invoiced amount becomes uncollectible.

Let's start by setting out our bad debt scenario. Your business, Cottage Furniture, has a customer called Decorate Your Life. Decorate Your Life has gone broke, owing you $300.00 for inventory. They go out of business, and you know you're not going to get paid. Their invoice keeps showing up on your Dashboard as overdue, and deleting it doesn't make sense, since you lost the inventory cost already. You decide to write off the invoice.

If you use Wave Payments and someone paid you, but then you refunded the invoice partially or in full, you won’t be able to delete the invoice. This is because, since real funds were moved on your business, writing it off best reflects the actual loss you experienced. You also need records of actual funds moved by Wave, your payment processor. As this is the case, writing it off is what we recommend.

Write off invoice to Bad Debt Expense

Right now, your bookkeeping includes $300 of income from Decorate Your Life. Whenever you create a new invoice in Wave, and approve the draft, it adds to your income, and creates a balance in Accounts Receivable until it is paid. This is because Wave invoicing is accrual-based.

You have not been paid the money, so you want the $300 Accounts Receivable asset to disappear, and to account for the loss against your business income. You also want to stop seeing that overdue invoice every time you log in to Wave.

The only way to get rid of the unpaid invoice, and the Accounts Receivable balance, is to mark the invoice as paid.

But you haven't been paid

In this scenario, the simplest thing to do is use a created bank account, that accountants traditionally refer to as a clearing account. A clearing account is an account in Wave that functions like a bank account, but doesn't represent a bank account that you have in the real world.

You create a clearing account exactly the same way you create any new account in Wave. We’ll also need a Bad Debt Expense account. If you haven't previously created these accounts, go ahead and create them now:

  1. Head to Accounting > Chart of Accounts
  2. Click Add a new account in the top right corner;
    • In the Account Type dropdown, select Customer Prepayments and Customer Credits, under Liabilities & Credit Cards.
    • In the Account Name section, enter Bad Debt Clearing account.
    • Optionally, add an Account ID and Description.
  3. Click Save.
  4. Click Add a new account in the top right corner again;
    • In the Account Type dropdown, select Operating Expense, under Expenses.
    • In the Account Name section, enter Bad Debt Expense account.
    • Optionally, add an Account ID and Description.
  5. Click Save.

The next stage is to mark the invoice as paid:

  1. Head to Accounting > Transactions.
  2. Click Add Income;
    • Under Description, enter something like Write Off Invoice #.
    • Under Account, choose Bad Debt Clearing account.
    • Under Amount, enter the total amount you're writing off (in this example, $300).
    • Under Category, choose Payment Received for an Invoice in Wave > Invoice #
  3. Click Save.

That's the overdue invoice and the Accounts Receivable balance taken care of. Next, write off the payment to your expenses:

  1. Head to Accounting > Transactions.
  2. Click Add Expense;
    • Under Description, enter something like Bad Debt on Invoice #
    • Under Account, choose Bad debt clearing account.
    • Under Amount, enter the total amount you're writing off (in this example, $300).
    • Under Category, choose the Bad Debt Expense account.
  3. Click Save.

You now have $300 of Bad Debt Expense that offsets the $300 income from Decorate Your Life, your Accounts Receivable no longer shows an outstanding balance, and your Bad debt clearing account has a $0 balance.

Frequently Asked Questions

What date to apply to the write-off transactions?

An important principle in accounting is the concept of matching. This means ensuring the revenues earned operating your business within a certain period line up with the expenses incurred to generate those revenues.

It's generally a good idea to date your write-off transactions the same as your invoice. You don't want to break prior reporting though, so bear in mind these conditions where you may need to date your write-off transactions differently:

  1. Your business charges and recovers sales tax, and you have already reported and/or paid sales tax for the period in which the original invoice was issued. Jump to this section for more information.
  2. The invoice was issued in your last financial year, and you have already completed your year-end statements and filed tax returns. We recommend speaking to your accountant in this situation, who may advise re-filing the prior year.

    Alternatively, you may choose to date the write-off transactions in the current financial year. This avoids changing your financial statements for the year that has closed.

What about sales taxes?

If you charge and recover sales taxes, writing off bad debt becomes a little more complex. Different jurisdictions have different rules about the conditions and timing under which you can deduct the sales tax element of your bad debts from your sales tax returns. Because of this, it is important you consult your accountant or tax authority directly, who can advise on your local rules.

If you operate in a state or province where the sales tax element of bad debt can be deducted directly from your Sales Tax liability, your accountant or tax authority may advise you to apply sales tax to your Bad Debt Expense account. This would be the same as you would when marking any expense to contain recoverable sales tax, and would offset the sales tax recognized on the paid invoice.

When it comes to the date of the write-off transactions, you could also choose to date them within the current period for which you have not yet reported sales tax.

If you have added non-recoverable sales taxes to an invoice, you can remove the sales tax from the invoice before writing it off.

Wouldn't it be simpler to delete the invoice?

It would be simpler, and if you don't have complex sales tax rules to follow, you might choose to do so. That said, there are three important reasons why it is better to write off the invoice instead:

  1. Your sales did include the $300 to Decorate Your Life. The loss of that $300 was a consequence of your client going out of business, not a failure to sell to them or do the work. Calculating your sales income including the $300 Decorate Your Life income is a more accurate understanding of what happened in your business.
  2. By recording your sales income and your bad debt expense, you get a sense of the cost of doing business on credit. If you divide your bad debt expense in each period by the Sales Income for the same period, you may see patterns, and be able to work out how much bad debt to expect as your business grows. (A change in bad debt expense could tell you about the quality of clients you are serving, or how effective your collections are.)
  3. If your former customer files for bankruptcy, you may have an opportunity to receive a share of the proceeds of the bankruptcy, even if it is only a small percentage of what you are owed. In this case, you will need your invoice to support your claim.

If the invoice was paid and refunded through Wave Payments, you can't delete the invoice. See this section above for more details.

Accounting for bad debt with the Allowance Method

The Allowance Method of accounting for bad debt is a more sophisticated approach, which involves additional steps, and is more complicated.

It also does a better job of matching bad debt expense to the sales in each accounting period, as an estimate for likely bad debts is made and updated in every accounting period. When an invoiced amount is unrecoverable, it is written off to the Bad and Doubtful Debt contra asset account.

In Wave, you would follow the same process to mark the invoice as paid using a clearing account as above. The difference is you would categorize the expense transaction as Bad and Doubtful Debt, not a Bad Debt Expense.

If you feel the Allowance Method may be more appropriate for your business, we encourage you to consult your accountant. Advising on the appropriate bases of estimation, and the detailed accounting steps required, is beyond Wave’s scope.