Bad debts: recovery, evidence and treatment

What the term means, and why it is misread

"Bad debt" is generally used for a balance a company no longer expects to recover and has therefore removed from its books. That is an accounting decision about how figures are presented, not a decision about the fate of the entitlement itself.

Confusing the two produces a poor practical outcome: companies close files in which something could still have been done, simply because the balance was written off at year end.

Writing off in the books versus the continuing right to claim

A write-off is an internal step taken by the company under its accounting policy and the accounting framework that applies to it. The right to claim the amount, by contrast, comes from the contract, the documents and the law, and it does not disappear because a creditor made an internal decision.

Put differently: a write-off changes what the financial statements show; it does not by itself change what can be claimed. A written-off debt remains claimable for as long as the documents survive and the legally available period for bringing the claim has not run out.

That period is not a single number. It varies with the nature of the transaction, the type of document and the applicable law, and it should be verified case by case before any decision is built on it.

When does a debt become distressed? There is no magic number

Fixed figures circulate — ninety days, or a hundred and eighty — as the point at which a debt supposedly becomes bad. That shorthand is inaccurate. The period a company uses to classify a balance is a matter of accounting policy, shaped by the nature of the business, the credit terms normal to it, and the accounting framework in force.

What matters more in practice is not age alone but the debtor's behaviour. Have they stopped responding? Have they denied the debt? Did they promise and not perform? Did they ask for a schedule and then default on it? A six-month balance with a cooperative debtor on a payment plan is nothing like a three-month balance with a debtor who has disappeared.

Where a bad debt appears in the financial statements

When a balance is written off or provided against, the effect normally runs through the income statement as an expense, reducing net profit for the period. The line it sits under, and how it is presented and disclosed, differ with the accounting framework applying to the company, its adopted policy and the nature of its business.

Two approaches are used in practice: writing the balance off directly once recovery is no longer expected, or creating an allowance for doubtful debts estimated by various methods — ageing analysis of receivables, a percentage derived from credit sales, or prior experience with a particular class of customer.

The choice of approach and of estimation method is not entirely free, because it is governed by the applicable accounting framework. It is therefore settled with the company's auditor, not by a general rule borrowed from another business.

What evidences that the debt is real

Before any treatment is considered, the file should contain material establishing three things: that there was an agreement, that the company performed its side, and that a specific amount fell due and was not paid.

In practice that means the contract, purchase order or accepted quotation; the invoices; proof of delivery or completion signed by the recipient; a reconciled statement showing payments and how they were allocated; and correspondence with the debtor. A cheque or a written acknowledgement of balance strengthens the file considerably, because it moves the discussion from whether the amount is owed to when it will be paid.

What evidences that recovery was not achievable

This is the point most often neglected. A company that wants to classify a balance as irrecoverable needs material showing that it genuinely tried — not simply an internal estimate.

A record of attempts normally consists of dated correspondence with the debtor; reconciliation requests and whatever came back; demand letters or notices together with proof of despatch; notes or summaries of meetings and calls; any payment plan that was agreed and not performed; and whatever is lawfully available about the debtor's status.

That record serves two purposes: it supports the accounting treatment, and it remains a sound basis for reopening the file later if the debtor's position changes.

Accounting and tax treatment

How a provision is made or a balance written off differs with the accounting framework applying to the company and with its adopted policy. The treatment of bad debts for tax purposes is subject to its own conditions and may require specific documentation.

The right step is therefore to consult the company's auditor or tax adviser before deciding, because what applies to one company may not apply to another. What is set out here is general information and is not a substitute for that review.

Formal routes where an amicable outcome is not reached

Where negotiation produces nothing, formal routes remain, and which one fits depends on the documents, the nature of the relationship and the applicable law. It may be a claim before the competent judicial body; it may be arbitration where the contract contains a valid and applicable arbitration clause; or it may end in a settlement recorded before the body hearing the dispute.

Once a judgment or an enforceable instrument is obtained, an entirely different stage begins — enforcement — and its success depends on there being assets or funds to enforce against. This point is frequently overlooked: obtaining a judgment is not the same as obtaining the money, and a file with nothing behind it can end in a judgment for the creditor and no recovery at all.

These routes run before the courts or the competent authorities and may require a licensed lawyer. Our role in them is to review the file, prepare the documents and coordinate with the licensed lawyer or the competent authority within the scope of our licence — not to conduct litigation or enforcement ourselves.

Can a written-off debt still be collected?

Yes, and it happens in practice. A write-off does not extinguish the entitlement, and a debtor's position can change: trading resumes, funding is obtained, or obligations need to be settled for a particular purpose.

Two checks come first, though: that the supporting documents still exist, and that the legally available period for bringing the claim has not expired in the circumstances of the case. Both precede any contact with the debtor, because an unsupported demand can weaken a position rather than strengthen it.

Practical steps for reviving an old file

Work begins by gathering whatever documents remain and putting them in date order, rebuilding a statement of account that can be defended, and verifying the debtor's current status and the correct entity to address — many old files fail because the demand went to an entity that no longer exists or was never the contracting party.

Documented, professional contact then follows, asking for reconciliation of the balance or putting forward a realistic settlement. On an old file, a partial settlement actually paid is frequently a better practical outcome than a full claim that stays unpaid.

Where the basis is sufficient and an amicable outcome cannot be reached, the next step is considered on the facts of the file, in coordination with a licensed lawyer or the competent authority where required.