If you have a client/s that have not paid their account you may reclaim the VAT element of the debt and write the net element off the balance sheet in the accounts.
There are two distinctions of bad debts:
- Bad Debt - a debt that will never be paid
- Doubtful Debt - a debt currently unpaid but may be paid in the future
These are accounted for in the financial accounts differently we is detailed below.
Reclaiming the VAT
Businesses on either the cash accounting or flat rate cash scheme will not financially have suffered in paying the output tax to HMRC as output tax is not due for payment until the bill has been paid.
Any business on the standard accounting scheme or flat rate invoice basis will however have paid HMRC the output tax.
Regardless of whether the VAT has been paid to HMRC, accounting for the bad debt has to be made on the VAT 100 so that the VAT is correct.
In the eyes of HMRC, a bad debt is a debt that remains unpaid for a period of six months or longer.
You can make an amendment on your VAT after the six months and retrospectively up to three years and six months.
To qualify, the bad debt amount must have been written off in the VAT account to the bad debt account.
The VAT amount is added to box 4, Input VAT on the VAT 100 form.
Accounting entries for the Bad Debt
Bad Debt
Once the debt is known to be a Bad Debt it should be written off the accounts as follows:
Debit - Bad Debt account (an expense on the profit & loss)
Credit Client account (reducing debtors total on the balance sheet)
Doubtful Debt
Although there is still a possibility that the debt may be paid, for accounting purposes the debtors balance has to be correct (so as to not overstate the assets of the company) on the balance sheet at the company year end.
Debit - Provision for doubtful debts on Profit and Loss account
Credit - Provision for doubtful debts on the balance sheet
If in the subsequent year the doubtful debt became a bad debt then the latter accounting entry would be reversed by a journal entry and the debt written off as a bad debt.
Larger businesses will have their own written policies on what percentage of their doubtful debtors may be accounted for according to the length of time the debt is unpaid.