Accounting for Small Business Debt

A business debt that you can’t collect is certainly costly, but how you account for this unfortunate situation depends on several factors. Debts are typically invoices to customers that will not be collected.

If you never received money that you expected, the loss is not the same as theft. Your business cannot lose cash that it never had. For this reason, a cash basis accounting system does not have any debt expense. Cash basis only counts income when payment is received. A cash basis business does not have any accounts receivable in its bookkeeping. Receivable amounts were never added because uncollected invoices are not yet counted as income.

Creating a receivable only occurs in bookkeeping that adds income using accrual basis. Accrual basis accounting counts a sale as income when it’s invoiced. If your business is accrual basis, the previously recorded income for an uncollectible invoice amount must be offset by a debt expense. The expense increase is balanced against a reduction to accounts receivable.

Most accounting software produces financial statements for either the cash or accrual method. Debt expense will only appear on the accrual income statement since only accrued income will include uncollected accounts receivable. The cash basis reports are unaffected. They show no debt expense because the expected income is already absent on the financial statements.

Costs associated with invoiced work represent cash lost for both cash basis and accrual basis. These expenses are captured regardless of whether customers pay the invoices you sent. But that’s an issue for your accounts payable system, not accounts receivable.