It is good business practice to have a policy in place that stipulates how your company deals with bad debts.
In case you aren’t aware, a bad debt is when an invoice is not going to be paid by a client or customer. It is a debt to you that has gone bad.
Besides hindering your cash flow, bad debts can be problematic for other reasons. According to SARS, you have invoiced that amount and therefore will be taxed on your income including this bad debt. Not only are you not receiving this money, but you are also expected to pay tax on it. Tax here refers to income tax and VAT.
The bad debt is simple to handle from an accounting point of view. You would simply process a journal that creates an expense called “Bad Debts”. In accounting terms, this is called writing off the bad debt (getting rid of it). If you are not sure about how to process this journal, please contact us.
When can I write off bad debt?
The answer is a tricky one. You should only write it off when you know it is not going to be paid. In the day to day running of the business, is simple to work out. Having said that, you cannot give that as a reason. There has to be a process to be able to say that the debt is bad. This should be a policy in your business.
An example of this process is this:
- Invoice sent out with due date according to terms and conditions
- 7 days after the due date, email sent requesting payment to be made
- Statement is sent
- 21 days after the due date, a statement is sent with covering email stating that payment is due
- Statement sent at every month-end
- 60 days after the due date, a letter is sent demanding payment
- 90 days after the due date, a final letter of demand is sent from a business stating that if payment is not made in X number of days, legal proceedings will commence
- After X days, you contact your lawyers and start that process according to the law of the land
This process must be recorded, and all documents must be kept. This is for two reasons:
- For the lawyers to pick up on as you have built a case for them to work with; and
- If SARS asks about why the debt has been written off, there is a full paper trail for them to see.
It is good business practice to have this process on record and in your terms and conditions.
What about the legal fees I paid to recover the debt?
You had to go to the lawyers to try and recover this debt and this costs money. The good news is that you can claim this an expense in your income statement for tax purposes. Any legal fees that are paid to recover the money, can be claimed as a tax deduction.
What happens if they do pay?
That’s great! It is a common occurrence for them to pay. If not the full amount, then at least part of it. If this happens, the payment will be allocated to an income account called “bad debts recovered”. Simple.
What about the VAT implications?
If you are a VAT vendor, there are VAT implications. But don’t worry, they are not at all complicated.
In fact, the treatment is the same. On the VAT side of things, when written off, you claim the VAT portion back as it is now an expense.
If, or when it is recovered, the VAT now pay becomes payable as normal with income.
The legal fees are a VAT deductible expense as normal if the firm is a VAT vendor.
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