Unpaid Invoices and Bad Debts

Written by Sally Fletcher for planIT, August 16 2011

When undertaking a contract, the payment terms should be clearly stated in the contract between the parties.  It is also advisable to have these terms stated within the body of all invoices raised.

When an invoice becomes late for payment, there are several courses of action that can be taken:

• Chasing the debt by post, telephone and email
• Charging interest on the debt to encourage early settlement
• Making a small claims court application
• Making an on-line small claims court application

Careful consideration needs to be given to the true cost of chasing debts.  Time is valuable and phoning and asking for money does not often bring results. Writing letters and retaining proof may have some effect but sending any more than two chasing letters is generally a waste of time. If you say or write that you will do something, it is important that you do so for the debtor to believe you're credible.

Charging Interest

Under the Late Payment of Commercial Debts (Interest) Act 1998, you have a statutory right to charge interest on debts where the contractual payment terms have not been met.

To qualify, the contract must be one for supplying goods or services.

The statutory qualifying time is 30 days before the interest can be applied, from either the delivery date of the goods or services or the date on which the debtor is notified of the debt, whichever is the later.  Interest can then be charged at a daily rate of 8% above the Bank of England base rate on the outstanding amount.  The base rate is set for 6 months starting from the 31st of December and 1st of July each year.

Administration fees may also be added:
£40 for debts up to £1000
£70 for debts between £1001 and £10,000
£100 for debts over £10,000

The following formula is used to calculate the interest:

The debt times the interest rate times the number of days late divided by 365.

Interest is due on the gross amount of the invoice including any VAT, but output VAT is only charged on the administration charge, not on the interest amount.

The debtor will need to be advised in writing, detailing the date that interest will be applied and details of the daily rate and administration costs that will be charged.  All correspondence should be sent by recorded delivery post and copies retained.

Payments received

If a part payment is received that states in full and final settlement, it is advisable not to accept or bank the payment.  By doing so, you are forming a contractual arrangement that you do accept the payment because you have banked it.  There would be no further course of redress to get the remainder of the debt.

If the debtor sends a letter stating that they will only be paying a percentage of a bill because of some dispute, retain the document.  It's important that you respond in writing retaining copies in case the dispute is taken further.  If you do nothing, it could later be challenged that you failed to respond and therefore accepted the circumstances.

If the above measures fail, a final redress can be made on-line with the small claims court providing there is no dispute. 

Where there is a dispute, you will need to make a paper application which you can obtain from your local court.  Cases that are unresolved are heard in the County Court, but an application should only be made as a final resort. Costs to commence an application start at £25 and increase according to the amount of the debt. Remember though, this could end up a costly procedure, especially if you need to employ the services of a solicitor to represent you.

Unpaid Debts

Other than debts collectible in the normal course of business there are two types of debt:

1)     A debt that will never be paid - A bad debt
2)     A debt currently not paid that may be paid in the future - A doubtful debt

Reclaiming VAT on Bad Debts

If a business accounts for VAT on a standard cash or flat rate cash accounting scheme then no VAT refund will be applicable as no output VAT will have been paid to HMRC.  It will however need to be accounted for to ensure the VAT account is correct.

Businesses using a standard invoice or flat rate invoice accounting scheme are eligible to reclaim the VAT element of the bad debt. This should be made on the next return due.

In the financial accounts, bad debts are accounted for as an expense in the profit and loss account and written off against the debtors on the balance sheet.

Please ask your account manager to make any journal accounting entries for you.

This brief is for guidance purposes only. In all cases we would recommend that you discuss any queries with professional advisors. planIT Services is a firm of Chartered Accountants regulated by the Institute of Chartered Accountants in England and Wales. Please feel free to contact us if you have any questions relating to this article or other accounting issues affecting contractors.