For example, you must not have waived or forgiven the debt, extinguished the liability in another way, or sold the debt. The debt must still be in existence, and not otherwise dealt with, when you write it off and claim a deduction. For example, you may have removed the debt from the customer’s account and recognised a bad debt expense. This means you must have made the decision to write off the debt and recorded that decision in writing before the end of the income year in which you claim a deduction. You need to write off the debt as bad before you can claim it as a bad debt deduction. For example, you may provide evidence of communications seeking to obtain payment of the debt, including reminder notices issued and attempts to contact the debtor by phone/mail. There are many ways to demonstrate an amount is no longer recoverable, and what constitutes a reasonable attempt will depend on the circumstances. This means it must be an amount that you have determined is unlikely to be recovered through any reasonable and commercial attempts.ĭepending on your circumstances, this does not always mean you need to have commenced formal proceedings to recover the debt (see example below). There must be a debt owing to you and it is genuinely bad. You need to determine that the debt is bad at the time you propose to write it off. You can only claim a bad debt deduction for amounts you have included in your assessable income, either in your tax return for the year you claim the deduction or in an earlier income year. To claim a bad debt deduction in an income year for an amount included in your assessable income that has not been recovered, you must do all of the following:
How to write off a debt as badĪ bad debt deduction may be claimed where you account for your assessable income on an accruals basis.
Therefore, writing off, forgiving, or waiving a debt for an amount of unpaid income will have no income tax consequences for you. If you account for your assessable income on a cash basis, you will not include an amount in your assessable income until it is received. There are different tax consequences for debt forgiveness or waiver and there may also be tax consequences for the debtor. Writing off a debt as bad is not the same as waiving or forgiving a debt. If you subsequently recover an amount that you wrote off as a bad debt and claimed as a tax deduction, the amount you recover must be included in your assessable income when you receive it. To claim a deduction for the assessable income that cannot be recovered, you need to write off the unpaid amount as a bad debt (see How to write off a debt as bad). If you determine there is no or little likelihood that an amount included in your assessable income will be recovered from the debtor, you may be able to claim that amount as a tax deduction. If you account for your assessable income on an accruals basis, you may be required to include an amount you earn as assessable income in your tax return before you receive payment of that amount. The accounting method you use to account for your assessable income affects whether you can claim a bad debt deduction: This unrecoverable income is also known as a 'bad debt'. Thus, the balance sheet and the accounting equation will show a reduction in inventory and in owner's or stockholders' equity.Deductions for unrecoverable income (bad debts)Īs a business owner, you may be able to claim a deduction for income that cannot be recovered from a customer or debtor. Since the amount of the write-down of inventory reduces net income, it will also reduce the amount reported on the balance sheet for owner's equity or stockholders' equity. If the amount of the Loss on Write-Down of Inventory is significant, it should be reported as a separate line on the income statement. If the amount of the Loss on Write-Down of Inventory is relatively small, it can be reported on the income statement as part of the cost of goods sold. Under FIFO and average cost methods, if the net realizable value is less than the inventory's cost, the balance sheet must report the lower amount. Example of Reporting a Write-down in Inventory
The debit in the entry to write down inventory is recorded in an account such as Loss on Write-Down of Inventory, which is an income statement account.
Often the balance in the current asset account Inventory is reduced through a credit to a contra inventory account, which is referred to as a valuation account. Under FIFO and average cost methods, when the net realizable value of inventory is less than the cost of the inventory, there needs to be a reduction in the inventory amount. How do you report a write-down in inventory? Definition of Write-down in Inventory