Journal entry for bad debt

A $1,200 invoice from May is still open in October. The customer has dissolved and there is nobody left to chase. Until someone writes it off, the balance sheet counts that $1,200 as money on its way in, and every report built on receivables is a little more optimistic than the business.

There are two ways to write it off, and they answer to different rules. GAAP wants losses estimated ahead of time through an allowance (ASC 326). The IRS only allows a deduction once a specific debt is actually worthless (IRC §166). Below are the entries for both, how to handle a customer who pays after all, the sales tax most businesses forget to reclaim, and the QuickBooks Online steps that keep the customer aging in step with the ledger.

Direct write-off vs allowance method

Accounting recognizes two fundamentally different methods for writing off bad debt:

Dimension	Direct write-off method	Allowance method (ASC 326)
When expense is recorded	In the period the specific debt proves worthless	In the period the original sale occurred (via estimate)
Accounts debited	Bad Debt Expense	Allowance for Doubtful Accounts
Accounts credited	Accounts Receivable	Accounts Receivable
P&L impact at write-off	Reduces net income immediately	Zero impact (expense was recognized previously)
Net AR impact at write-off	Reduces net Accounts Receivable	Zero impact (gross AR and allowance decrease equally)
GAAP compliance	Acceptable only when bad debts are immaterial	Required for GAAP financial statements
IRS tax compliance	Required under IRC §166(a)	Disallowed for federal income tax deductions

Method 1: The direct write-off entry (IRS Tax Basis)

Under the direct write-off method, no expense is recorded until an identifiable event confirms that a specific customer cannot or will not pay.

On October 15, 2026, you determine that a $1,200.00 invoice billed to Acme Corp on May 10 is completely uncollectible after the customer dissolved without assets.

Date	Account	Account type	Debit	Credit
Oct 15	Bad Debt Expense	Expense	1,200.00
Oct 15	Accounts Receivable	Accounts Receivable		1,200.00

The $1,200.00 lands in October’s profit and loss as bad debt expense, and the receivable comes off the balance sheet at the same moment.

IRS rules under IRC §166 for tax deductions

For federal income tax returns across C corporations (Form 1120), S corporations (Form 1120-S), partnerships (Form 1065), and sole proprietorships (Schedule C), the IRS strictly requires the direct write-off method:

1. IRC §166(a) Worthlessness Test: Taxpayers can deduct business bad debts only in the tax year in which the debt becomes wholly or partially worthless. A partially worthless debt is deductible only up to the amount charged off on the books that year (§166(a)(2)). You must demonstrate objective evidence of worthlessness (such as bankruptcy filings, unsatisfied court judgments, or defunct corporate status).
2. Repeal of Reserve Method: The Tax Reform Act of 1986 repealed former IRC §166(c), so no taxpayer can deduct a bad debt reserve estimate. The only exception is certain small banks under IRC §585.
3. Cash-Basis Taxpayers: A cash-basis business that never recognized the invoice in revenue cannot take a bad debt deduction. You cannot deduct income that you never reported on a tax return.

Method 2: The allowance method (GAAP / ASC 326)

Under US GAAP, the matching principle requires expenses to be paired with the revenues they helped generate in the same accounting period. Because some customer default is statistically inevitable, companies estimate expected credit losses rather than waiting for invoices to default months later.

Under ASC 326 (Current Expected Credit Losses, or CECL), the allowance method requires two separate journal entries:

Stage 1: Estimating the bad debt reserve at period end

On December 31, 2026, an aging analysis of your $100,000.00 accounts receivable ledger indicates that an estimated $4,500.00 will eventually become uncollectible. Assuming your existing allowance balance is zero, record the adjusting entry:

Date	Account	Account type	Debit	Credit
Dec 31	Bad Debt Expense	Expense	4,500.00
Dec 31	Allowance for Doubtful Accounts	Contra Asset (AR)		4,500.00

Allowance for Doubtful Accounts is a contra-asset account that sits directly beneath Accounts Receivable on the balance sheet:

• Gross Accounts Receivable: $100,000.00
• Less: Allowance for Doubtful Accounts: ($4,500.00)
• Net Realizable Value of Accounts Receivable: $95,500.00

Stage 2: Writing off a specific invoice under the allowance method

When Acme Corp’s $1,200.00 invoice is confirmed uncollectible in the subsequent year on March 15, 2027, you write off the specific invoice against the existing reserve:

Date	Account	Account type	Debit	Credit
Mar 15	Allowance for Doubtful Accounts	Contra Asset (AR)	1,200.00
Mar 15	Accounts Receivable	Accounts Receivable		1,200.00

Two things are true after this entry:

1. Net Income Impact is $0.00: Zero expense is recorded on March 15. The expense was already recognized through the December 31, 2026 allowance estimate, in the same year as the May 10 sale.
2. Net Realizable Value is Unchanged: Before this entry, gross AR was $100,000.00 less $4,500.00 reserve = $95,500.00 net. After writing off $1,200.00, gross AR is $98,800.00 less $3,300.00 reserve = $95,500.00 net.

Recording bad debt recoveries

Occasionally, a customer whose invoice was written off sends an unexpected payment months or years later. Under double-entry accounting, never deposit that check directly into miscellaneous income or bank feed income. You must reverse the write-off to preserve customer audit trails.

Case A: Recovery under the allowance method

When Acme Corp pays $1,200.00 on November 10, 2027, after an earlier write-off:

Step 1: Re-establish the receivable

Date	Account	Account type	Debit	Credit
Nov 10	Accounts Receivable	Accounts Receivable	1,200.00
Nov 10	Allowance for Doubtful Accounts	Contra Asset (AR)		1,200.00

Step 2: Post the cash collection

Date	Account	Account type	Debit	Credit
Nov 10	Checking	Bank	1,200.00
Nov 10	Accounts Receivable	Accounts Receivable		1,200.00

Case B: Recovery under direct write-off

If you use the direct write-off method and collect on a debt written off in a prior tax year, debit Checking for $1,200.00 and credit Bad Debt Recovery (an Other Income account) for $1,200.00, recognizing taxable income under the IRC §111 tax benefit rule.

The state sales tax recovery trap

Sales tax is the part of a write-off most businesses miss.

Suppose an accrual-basis business sold taxable equipment for $1,000.00 plus 8% sales tax ($80.00), delivering a total invoice of $1,080.00:

• Original Debit: Accounts Receivable $1,080.00
• Original Credit: Sales Income $1,000.00
• Original Credit: Sales Tax Payable $80.00

When that invoice was issued, the business remitted $80.00 out of pocket to the state Department of Revenue on its monthly sales tax return.

If the customer defaults and you simply debit Bad Debt Expense for $1,080.00, two problems occur:

1. You overstate bad debt expense by $80.00, because sales tax was never company revenue.
2. You forfeit an $80.00 cash credit from the state taxing authority.

Most state tax jurisdictions (including California under CDTFA Reg. 1642, Texas under Tax Code §151.426, and Florida under Admin. Code Rule 12A-1.012) permit businesses to claim a sales tax credit or deduction for taxes remitted on accounts written off under IRC §166.

The proper write-off entry claiming the sales tax credit:

Date	Account	Account type	Debit	Credit
Oct 15	Bad Debt Expense	Expense	1,000.00
Oct 15	Sales Tax Payable	Other Current Liab	80.00
Oct 15	Accounts Receivable	Accounts Receivable		1,080.00

Debiting Sales Tax Payable reduces your current liability owed to the state on your next sales tax filing, recovering the $80.00 tax paid on uncollected funds.

How to write off bad debt in QuickBooks Online

Writing a manual journal entry crediting Accounts Receivable in QuickBooks Online is a mistake. QuickBooks requires a customer on the line, so the credit lands on the customer as an unapplied credit, but it does not close the open invoice. The invoice and the credit sit side by side on the aging report and customer statements until someone links them.

Follow this standard Intuit workflow to write off bad debts cleanly:

Step 1: Create a Bad Debt clearing item

1. Open Products and services.
2. Select New > Non-inventory.
3. Name the item Bad Debt.
4. In the Income account dropdown, select your Bad Debt Expense account (Account Type: Expenses, Detail Type: Bad debts). A credit memo posts to the item’s income account, so this is what routes the write-off to the expense account.
5. Leave “I sell this product/service to my customers” checked so the item appears on credit memos. Mark it non-taxable if you are writing off untaxed invoices.

Step 2: Issue a Credit Memo

1. Select + New > Credit Memo.
2. Select the customer whose invoice is uncollectible.
3. In the Product/Service grid, select your Bad Debt item.
4. Enter the uncollectible amount. If the original invoice included sales tax, configure the credit memo to match the tax rate so QuickBooks automatically debits Sales Tax Payable and adjusts your sales tax liability reports.
5. Save and close.

Step 3: Apply the Credit Memo to the open invoice

1. Select + New > Receive Payment.
2. Select the customer name.
3. In the Outstanding Transactions list, check the unpaid invoice.
4. In the Credits list, check the Credit Memo created in Step 2.
5. Confirm the Amount Received field displays 0.00.
6. Select Save and close.

The open invoice is closed, Accounts Receivable is reduced, the bad debt expense is posted, and your customer aging report stays completely reconciled. Compare this with standard vendor bill processing in our guide on journal entries for accounts payable and our complete hub of journal entry examples.

When old invoices clutter your aging reports

A healthy accounts receivable sub-ledger should tie to your balance sheet down to the penny. When aging reports contain two-year-old open invoices, unapplied customer credits, and negative receivable balances, the books need cleaning up before anyone files a return from them.

Ledgerbrook cleans up neglected accounts receivable and historical bookkeeping records under a published fee schedule:

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Writing off what will not be collected is part of reviewing receivables in every month-end close, and an allowance estimate belongs in the same close. The journal entry reference has the rest of the series, and if stale invoices are distorting your receivables, send the file for a free review or see how QuickBooks cleanup works.