Account for bad debt with the direct write-off method

Create bad debt accounts

Record a payment

Write off the payment

Frequently asked questions

Account for bad debt with the allowance method

Account for bad debit with the direct write-off method

The direct write-off method accounts for bad debt when an invoiced amount becomes uncollectible. You can use this method if you have an unpaid invoice or an invoice that will only be partially paid.

If you use Wave’s online payment feature and someone paid you through the invoice, but then you refund any amount, you can’t delete the invoice since real funds were moved. Writing off the invoice best reflects the actual loss you experienced and maintains records of the funds moved by Wave.

If the invoice is in a foreign currency, see Write off a foreign currency invoice.

Create bad debt accounts

When 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’s paid. This is because Wave’s payment feature is accrual-based.

You have not been paid the full invoice amount, so you want the Accounts Receivable balance to disappear and to account for the loss against your business income.

The only way to reduce the Accounts Receivable balance is to mark the invoice as paid. To do this, create a clearing account. A clearing account functions like a bank account but doesn’t represent a bank account that you have in the real world.

You also need a Bad Debt Expense account. To create these accounts:

        1. On the left-side menu, select Accounting > Chart of Accounts.
        2. Click Add a New Account in the top right corner.
        3. In the Account Type dropdown, select Customer Prepayments and Customer Credits.
        4. For the Account Name, type Bad Debt Clearing.
        5. Click Save.
        6. Click Add a New Account in the top right corner again.
        7. In the Account Type dropdown, select Operating Expense.
        8. For the Account Name, type Bad Debt Expense.
        9. Click Save.

Record a payment

The next step is to mark the invoice as paid.

        1. On the left-side menu, click Accounting Transactions.
        2. Click Add Income.
        3. For the Description, enter something like Write Off Invoice #.
          • In the Account dropdown, choose Bad Debt Clearing.
          • For the Amount, enter the total amount you're writing off.
          • In the Category dropdown, choose Payment Received for an Invoice in Wave, and select the relevant invoice.
        4. Click Save.

This accounts for both the overdue invoice and the Accounts Receivable balance.

Write off the payment

        1. Head back to Accounting > Transactions.
        2. Click Add Expense;
          • For the Description, enter something like Bad Debt on Invoice #
          • In the Account dropdown, choose Bad Debt Clearing.
          • For the Amount, enter the total amount you're writing off.
          • In the Category dropdown, choose Bad Debt Expense.
        3. Click Save.

You now have a bad debt expense that offsets the lost income from your customer, your Accounts Receivable no longer shows an outstanding balance, the invoice is no longer overdue, and your Bad Debt Clearing account has a zero balance.

Frequently asked questions

What date will apply to the write-off transactions?

Wave advises to date your write-off transactions the same as your invoice. However, this may affect prior reporting, 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 or paid sales tax for the period in which the original invoice was issued. Head to this section for more information.
    2. The invoice was issued in your last fiscal year, and you have already completed your year-end statements and filed tax returns. Wave advises speaking to your accountant in this situation.

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

What happens to the sales taxes on the invoice?

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. You must 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.

For the date of the write-off transactions, you can 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.

Can I just delete the invoice?

There are three important reasons why it is better to write off the invoice instead:

    1. Your sales included the funds sent by your customer. The loss of that income was a consequence of their lack of payment (or a refund), not a failure to sell to them or do the work. Calculating your sales income including the expected income is a more accurate understanding of what happened in your business.
    2. By recording your sales income and your bad debt expense, you learn more about 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.
    3. If your former customer files for bankruptcy, you may have an opportunity to receive a share of the proceeds of the bankruptcy. In this case, you will need your invoice to support your claim.

Accounting for bad debt with the allowance method

The Allowance Method of accounting for bad debt has more steps and is more complicated.

It is better at matching bad debt expenses 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, follow the same process to mark the invoice as paid using a clearing account as above but categorize the expense transaction as Bad and Doubtful Debt.

If you want to use the Allowance Method, consult your accountant. Advising beyond the information in this article is beyond Wave’s scope.