Doubtful debts: allowance or write-off?
The difference between an allowance for a doubtful debt and a write-off of a bad one, the entries for each, and how both are handled in your books.
By Achekam · · 5 min read · For Running a business businesses in South Africa, Nigeria, Kenya
Every business that sells on credit ends up with a few customers who stop paying. One has gone quiet for months. Another is in a dispute you may lose. A third has closed its doors. The question at month-end or year-end is not only "will we get this money?" but "what do the books say in the meantime?"
There are two different tools for this, and they are often confused. An allowance says, "We may not collect this, so we will not count all of it as an asset." A write-off says, "This is gone." They are recorded differently, they affect profit at different times, and only one of them stops you chasing the customer.
Doubtful is not the same as bad
Investopedia defines a bad debt as an amount owed by a customer that is unlikely to be collected, resulting in a financial loss. In practice, debts move through stages:
- Current: within terms, nothing to worry about.
- Overdue: late, but the customer is still talking to you.
- Doubtful: there is real reason to think part or all of it will not be paid, but you have not given up.
- Bad: you have done what you reasonably can, and the debt will not be recovered.
The allowance belongs to the doubtful stage. The write-off belongs to the bad stage.
The allowance: still chasing, but honest about the asset
ACCA explains that an allowance for receivables presents trade receivables at a realistic value without writing the debt off, so the balance stays on the customer's account and collection continues. That is the key point for an owner: making an allowance does not tell the customer anything, close their account or forgive the debt. It changes what your balance sheet claims you are owed.
Investopedia describes how it is recorded: debit bad debt expense, credit a contra-asset account called the allowance for doubtful accounts. On the balance sheet, the allowance is netted against total receivables so that only the amount you expect to collect is shown.
Only the movement hits profit
ACCA stresses that only the increase or decrease in the allowance goes to the statement of profit or loss each year. A worked example in words:
- At the end of the first year, you review the aged debtors and set up an allowance. The whole allowance is charged to profit or loss, because it went from nothing to something.
- At the end of the second year, you review again. If the allowance needs to be larger, only the increase is charged. If it can be smaller, because some doubtful customers paid, the decrease is a credit to profit or loss.
- The allowance account carries forward from year to year. You top it up or release part of it; you do not start again from nothing.
This is why an owner sometimes sees "bad debts" as a negative cost in a good year: the allowance came down.
Writing off: when the money is gone
A write-off removes the debt from the customer's account. The usual entry, where an allowance already exists for that customer, is to debit the allowance and credit trade receivables. Where no allowance was made, the debit goes to bad debt expense. Either way, the customer's balance is cleared and the debt no longer appears in your debtors.
Because a write-off ends collection in the books, it deserves a second pair of eyes. A short checklist before approving one:
- Has the customer received statements and reminders, and is there a record of them?
- Is the debt older than your policy's limit, or is there a specific event, such as the business closing?
- Is any part of it disputed, and should that part be a credit note instead?
- Who approved the write-off, and is that recorded with the reason?
If money later arrives from a debt you wrote off, record it as income in the period it arrives, or reinstate the debt and receipt it, as your accountant prefers. Do not leave it unexplained in the bank.
The direct write-off method
Some small businesses skip the allowance and simply write debts off when they are found to be uncollectible. Investopedia explains, in a US accounting and tax context, that this direct write-off method records the exact amount lost but fails to follow the matching principle of accrual accounting: the loss lands in a later period than the sale that caused it.
That is why accountants generally prefer the allowance. A business that made large credit sales in one year, some of which will never be paid, shows a truer profit for that year if it recognises the likely loss then, not two years later. How each method is treated for income tax differs between South Africa, Nigeria and Kenya, so the tax side is one for your accountant.
Doing both in Achekam
Achekam keeps your receivables aged into 0-30, 31-60, 61-90, 91-120 and over 120 days, with overdue totals. That ageing is the starting point for an allowance: the older bands are where doubtful debts usually sit.
For the allowance itself, use a manual journal. Each business has its own chart of accounts, and accounts can be added, so you can create an allowance account alongside trade receivables and a bad debts expense account. An unbalanced journal, or one dated in a closed month, is refused, and a posted journal is corrected only by a reversal, so the history of each year's adjustment stays visible.
For a debt that is truly gone, Achekam's write-off works on the invoice itself: an unpaid debt can be written off once a partner approves. Separately, an administrator can void an issued invoice that has no payments or credits, which reverses its journal. A void is for an invoice that should never have been issued; a write-off is for a real sale the customer will not pay for. Do not use one in place of the other.
The industry articles show how this plays out in practice: writing off irrecoverable legal fees and deciding on school fee arrears from the ageing.
Your next step
Investopedia's article on bad debt and how it is estimated and written off sets out the allowance and direct write-off methods side by side. Before your next month-end, pull the aged debtors, mark which balances are doubtful and which are truly bad, and agree with your accountant how the allowance will be worked out each year, so the method stays the same from one year to the next.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
