Bad debt
A bad debt is a receivable that a business has concluded it will not be paid, requiring the outstanding amount to be written off as an expense in the profit and loss account and the debtor balance removed from the balance sheet.
A bad debt arises when an invoice has been raised, income recognised, and VAT potentially already paid to HMRC — but the customer has not paid and is unlikely ever to do so. Writing it off acknowledges the economic reality: the asset no longer exists. The amount moves from the debtors ledger to a bad debt expense account, reducing profit for the period.
Bad debt relief and VAT
In the UK, if you account for VAT on an accruals basis and the debt is more than six months overdue, you can reclaim the VAT originally paid through a Bad Debt Relief adjustment on your VAT return. For a £1,200 invoice (£1,000 + £200 VAT), that means recovering £200 from HMRC. The relief must be claimed within four years and three months of the original invoice’s tax point.
Writing off in Xero
In Xero, you write off a bad debt by raising a credit note coded to a bad debt expense account and allocating it against the overdue invoice. This clears it from the aged debtors report and posts the correct double-entry: debit bad debt expense, credit accounts receivable. Any VAT component is then handled via the VAT return adjustment. Leaving old unpaid invoices open overstates both income and debtors, making month-end figures unreliable.