Every reporting period, finance leaders must determine how much of the revenue on their books will actually be converted into cash. This decision affects more than reported profits; it reflects the accuracy of financial reporting and the strength of internal controls.
Under accrual accounting, revenue is recognised when goods or services are delivered, not when cash is received. The challenge for finance leaders is therefore not whether revenue was valid, but whether the resulting receivable will be collected. Bad debt, doubtful allowances, and impairments exist to address this credit risk.
In many organisations, however, these concepts only get real attention during reporting periods. By this time, invoices are old, customers have gone quiet, and finance teams are forced into last-minute clean-ups to protect the balance sheet. What should be a measured forward-looking assessment of credit risk becomes a reactive exercise where controllers reassess optimistic assumptions and make uncomfortable adjustments under time pressure, but it doesn’t always have to be that way.
This guide explains how bad debt, doubtful allowances, and impairments function not just as accounting outcomes, but as ongoing risk-management tools. It shows how finance leaders can embed them into day-to-day accounts receivable management to identify risk earlier, reduce P&L surprises, protect cash flow, and minimise write-offs, long before reporting pressure sets in.
What are bad debt, doubtful allowances and impairments?
Bad Debt
Bad debt represents money that a business has accepted it will not collect. At this stage, all reasonable efforts to recover the invoice have failed, or circumstances make collection unrealistic. While bad debt does not reverse recognised revenue, it reduces profitability through the recognition of a credit loss expense. Persistently high levels of bad debt may indicate weaknesses in credit management or underlying operational inefficiencies
Common indicators of potential bad debt include invoices that are significantly overdue, typically 90 days or more, and customers with inconsistent or late payment behaviour. Sudden deterioration in a customer’s financial health, long-standing disputes, and industries facing economic downturns also signal risk. Monitoring these factors proactively through ageing reports, risk scoring, and automation helps finance leaders identify potential losses before they hit the balance sheet.
Accounting treatment
When a receivable is deemed uncollectable:
Profit & Loss:
Recognise bad debt expense (or utilise an existing allowance).
Balance Sheet:
Remove the receivable from accounts receivable.
Typical journal entries
Direct write-off:
Dr Bad Debt Expense
Cr Accounts Receivable
If an allowance exists:
Dr Allowance for Doubtful Accounts
Cr Accounts Receivable
Doubtful Allowances: (Allowance for Expected Credit Losses)
A doubtful allowance is an estimate of how much of your current receivables are unlikely to be collected. Unlike bad debt, which is recognised when collection fails, this is a proactive estimate. Doubtful allowances do not adjust revenue. Instead, they reduce the carrying value of accounts receivable to reflect expected recoverability, ensuring financial statements are realistic rather than optimistic.
Most organisations calculate doubtful allowances using ageing buckets and historical default rates. Common calculation methods include:
Historical data method: Based on past customer payment patterns and default rates.
Ageing method: Assigns probabilities of default based on how long invoices are outstanding.
Specific account review: Adjusts for known customer issues such as bankruptcy or disputes.
Accounting Treatment
When setting or updating an allowance:
Profit & Loss:
Recognise an expected credit loss expense.
Balance Sheet:
Record a contra-asset that reduces accounts receivable.
Typical journal entry
Dr Credit Loss Expense
Cr Allowance for Doubtful Accounts
The allowance remains until it is either utilised (when a receivable is written off) or re-measured based on updated risk.
Impairments
Impairment occurs when an asset’s carrying value exceeds its recoverable amount. In accounts receivable, this means recognising that the expected value of a receivable has permanently declined, even if the invoice is not yet overdue and the customer has not formally defaulted. Impairments ensure that financial statements reflect true economic value and prevent profits from being overstated.
Common triggers for impairment decisions include customer financial difficulties, prolonged disputes, or adverse market conditions. Recognising impairments early requires judgement and confidence, as it involves acknowledging potential losses before they are fully realised.
Accounting treatment
When impairment indicators exist:
Profit & loss:
Recognise an impairment loss.
Balance sheet:
Reduce the carrying value of the receivable (or increase a specific allowance).
Typical journal entry
Dr Impairment Loss
Cr Allowance for Impaired Receivables
Under standards such as IFRS 9, impairments rely on expected credit loss (ECL) models, which emphasise:
forward-looking information
customer-specific risk
changes in credit quality, not just ageing
Accounting-wise, impairments sit between allowances and bad debt. Operationally, they reflect situations where recovery is unlikely unless conditions materially improve.
How bad debts, doubtful allowance and impairments work together
Bad debt, doubtful allowances, and impairments describe different stages of the same risk journey:
Bad debt represents realised loss.
Doubtful allowances represent expected loss across a portfolio.
Impairments represent identified losses on specific exposures.
Concept | Definition | Accounting treatment | Typical GL coding |
Bad debt | Amounts that are confirmed to be uncollectible | Write off the receivable. If an allowance exists, write off against the allowance.
If no allowance exists, recognise expenses directly in P&L. | With allowance:
Dr Allowance for Doubtful Accounts (BS – contra AR)
Cr Accounts Receivable (BS)
Without allowance:
Dr Bad Debt Expense (P&L)
Cr Accounts Receivable (BS) |
Allowance for doubtful accounts | Estimate of potential future credit losses | Recognise an expense and create a contra-asset to reduce net receivables. Adjust periodically based on updated estimates. | To increase allowance:
Dr Impairment Loss / Bad Debt Expense (P&L)
Cr Allowance for Doubtful Accounts (BS – contra AR)
To reduce allowance:
Dr Allowance for Doubtful Accounts
Cr Impairment Reversal / Credit Loss Recovery (P&L) |
Impairments | Adjust asset carrying value to recoverable amount | Reduce the carrying amount of the asset and recognise an impairment loss in P&L. For receivables, this is usually via a loss allowance. | Financial assets:
Dr Impairment Loss (P&L)
Cr Loss Allowance / Allowance for
Non-financial assets (e.g. PPE, intangibles): Dr Impairment Loss (P&L)
Cr Asset Impairment / Accumulated Impairment (BS) |
Example:
A company has trade receivables of 100,000 and estimates that 5,000 may not be collected.
The company recognises an impairment expense of 5,000 and records an allowance of 5,000.
Later, when 1,200 is confirmed as uncollectible, the receivable is written off against the allowance, with no further impact on profit.
Most judgment errors occur in the grey zone between slightly late and uncollectable. This includes slow-but-sure payers, below-threshold balances, and situations where the commercial relationship masks deteriorating creditworthiness. Without a central source of truth, no one owns the decision to act, increasing P&L volatility.
The AR operational gap
Many teams focus on bad debts only after invoices go unpaid, but the problem often starts much earlier. Small operational failures like slow responses to billing queries, missing billing details, incorrect PO numbers, unresolved disputes, missed follow-ups, and inconsistent account prioritisation can compound over time, increasing the risk of bad debt.
Early warning signs often do not live in financial systems; they are hidden in email threads, CRM notes, support tickets, dispute logs, and quietly slipping payment promises. Addressing this gap requires structured processes for tracking enquiries, resolving disputes, maintaining follow-ups, and prioritising accounts by risk.
How finance leaders can stop bad debt before the next reporting cycle
Understanding bad debt, doubtful allowances, and impairments is only part of the job. The real impact comes from knowing when and how to intervene, while invoices are still recoverable.
Most bad debt does not happen suddenly. It builds quietly over weeks or months through unanswered questions, slow approvals, broken payment promises, and inconsistent follow-ups. By the time balances are written off or impaired, the outcome is already locked in.
The steps below outline how finance leaders can stop this progression before the next reporting cycle.
Step 1: Identify risk early, not just overdue balances
Do not wait for invoices to age into 60 or 90 days past due. Early risk often shows up as delayed replies, partial payments, repeated billing questions, or customers going quiet after committing to pay. These signals appear long before formal default.
Step 2: Centralise visibility of AR activity
Risk is often hidden across inboxes, spreadsheets, CRM notes, and support tools. Without a clear view of open queries, disputes, and follow-ups, finance teams cannot see where momentum is slowing. Centralising this information is critical to acting in time.
Step 3: Act while balances are still recoverable
Intervention is most effective when invoices are recent. This means resolving disputes quickly, clarifying documentation, escalating to the right contact, and confirming payment timelines while the customer is still engaged.
Step 4: Prioritise accounts by risk, not just balance size
Not all overdue invoices carry the same risk. A previously reliable customer showing new delays may deserve more attention than a chronically late payer. Finance teams should prioritise based on behaviour changes, responsiveness, and payment consistency.
Step 5: Align operational action with accounting judgement
Allowances and impairments should reflect what is happening operationally. If follow-ups are failing, disputes are unresolved, or customers are disengaging, this should feed directly into provisioning decisions not be discovered months later during close.
Handled consistently, these steps allow finance teams to influence outcomes before they become accounting adjustments.
Q1 checklist: Are you managing bad debt early enough?
Use this checklist at the start of the year to assess whether risk is being addressed before the next reporting cycle.
Do we have visibility into unresolved billing queries and disputes?
Are promise-to-pay dates tracked and actively monitored?
Can we see which customers are becoming less responsive?
Are follow-ups consistent across all accounts and regions?
Do we prioritise accounts based on risk signals, not just ageing?
Are operational issues feeding into allowance and impairment decisions?
Do we intervene while invoices are still recoverable?
Are responsibilities for follow-ups and escalations clearly owned?
Can we explain allowance movements with operational evidence?
Are we fixing causes, not just adjusting outcomes at year end?
If several of these questions cannot be answered confidently, bad debt is likely being managed too late.
Why collection behaviour matters
Late payments are often the earliest and clearest signal of credit risk. How a customer responds to reminders, how much effort is needed to secure payment, and the speed of dispute resolution all provide insights that traditional accounting models cannot capture.
Finance teams often struggle to act on these signals because collection activity is fragmented, manual, or inconsistent. Centralising visibility into follow-ups, disputes, and customer responses gives teams real-time insight into the health of their receivables.
Modern AR automation tools like Paraglide can support this process by highlighting high-risk accounts, consolidating accounts receivable activity, and providing a clear view of outstanding actions. With these systems, teams can respond faster, prioritise efforts where they matter most, and translate operational signals into informed accounting decisions.
Final thoughts
Bad debt, doubtful allowances, and impairments are more than accounting concepts; they are practical levers that allow finance leaders to anticipate risk, protect cash flow, and make informed, confident decisions.
By understanding how these concepts relate, spotting early warning signals in collections behaviour, and implementing a structured decision-making framework, finance teams can move from reactive write-offs to proactive management. Treating accounts receivable as a portfolio of risk, rather than a series of individual invoices, transforms receivables from a source of uncertainty into a predictable, manageable component of business performance.
Proactive management transforms accounts receivable from a source of uncertainty into a strategic asset. With disciplined processes, clear operational visibility, and forward-looking accounting, finance teams can reduce write-offs, safeguard cash flow, and make confident, informed decisions that strengthen the organisation’s financial health.