Who Decided That Invoice Was Never Getting Paid? Why Your Agency Needs a Written Policy for Credit Memos and Write-Offs

By Craig S. Cody, CPA, Certified Tax Coach.

An overdue invoice doesn't disappear on its own. Somebody makes it disappear.

Every marketing or PR agency should have a written policy that says who approves every credit memo, write-off and void, what reason and signoff go with it, when the decision gets made, and who reviews receivables along the way. Without that policy, the person who has access to the books writes the policy for you, one invoice at a time.

A recent conversation with a client and his financial team revealed exactly that. The bookkeeper had been issuing credit memos on overdue invoices. There was no specific policy in place. So someone took it upon themselves to remove overdue invoices from the books.

Is This a Bookkeeper Problem?

No. It's a policy problem, and I want to be clear about that before anything else.

A bookkeeper looking at an aging report full of old invoices is under pressure to make it look clean. If nobody has said what to do with an invoice that's 120 days late, the bookkeeper is going to decide. That decision might even be a reasonable one. It's still a decision about your money that you didn't make.

When I worked midnight tours in Manhattan, it was a skeleton crew and most of the bosses were home in bed. Nobody handed you "use your judgment" and walked away. You had a short list of what you handled yourself and a shorter list of what you woke somebody up for. That list was a policy, and it's the reason a quiet night didn't turn into a mess by morning.

Your bookkeeper deserves the same list. So do you.

Is a Credit Memo Better or Worse Than a Write-Off?

Neither. A credit memo is just as bad as a write-off, especially when you don't know either one is happening.

They land in different places. A write-off moves the unpaid invoice to a bad debt account. A credit memo reduces revenue. In Workamajig, for example, a credit memo posts as a negative debit to AR and a negative credit to revenue, and the reduction shows up in the project. QuickBooks works the same way, because a credit memo runs through the same income accounts as the invoice it offsets.

The result for you is the same: money your agency billed is gone from your receivables, and nobody asked you. When that happens without your knowledge, three things go wrong at once:

• Nobody chased the money. An invoice that might still have been collected is off the books.
• Your aging report looks clean, so the one report designed to warn you about slow payers stops warning you.
• Your numbers move, and nobody can tell why. Revenue or bad debt changes, and so does your margin by client and by account manager. If you've built a gross margin by account manager report, an adjustment you never saw quietly changes who looks profitable.

That last one matters more than it sounds. If you can't explain a number, you can't defend your agency's numbers to a lender, a partner or a buyer.

Does It Change Your Taxes?

Handled correctly, a credit memo and a write-off have the same tax effect. What changes the answer is how your agency reports income.

If you're on the accrual method, you reported that invoice as income when you billed it. Handled correctly, either one takes that income back out. A write-off does it as a bad debt deduction under Section 166, in the year the invoice actually becomes worthless, with support showing it's worthless. A credit memo does it as a reduction of the sale.

If you're on the cash method for tax, you never reported that unpaid invoice as income in the first place. The regulations are direct about it: an unpaid fee isn't deductible as a bad debt unless the income was already included on a return. So there's no tax deduction either way. The damage is to the books you manage by, not to the return. (If your books are on accrual and your return is on cash, that's common and often smart; I wrote about running one set of books with two answers.)

Either way, the bigger cost usually isn't tax. It's that you're making decisions on numbers that were edited without you.

What Should the Policy Say?

It doesn't need to be long. One page is plenty. It needs to answer five questions:

1. Who approves it? The owner, the CEO or one designated individual approves every credit memo and every write-off. Not the large ones. Every one. Whoever enters it in the books isn't the one who decides it.
2. What comes with the approval? A written reason and a signoff from the approver, on every adjustment. "Cleanup" isn't a reason.
3. When does the decision get made? There's no rush to write off an invoice or issue a credit memo. Make the call when the data for your tax returns is ready to be finalized. Until then, the invoice stays on the books and someone keeps asking for the money.
4. Which tool for which situation? A credit memo is for a real price change or a billing error. A write-off is for a debt you've decided you can't collect. A void is for an invoice that should never have gone out. Writing that down stops one tool from being used for all three.
5. Who reviews receivables, and how often? Review them regularly through the year: every open invoice, how old it is, and who's following up on it. Do that, and the decision at tax time is a blip, because nothing on the list is a surprise. It's also the review that would have caught the problem I described above.

One more principle sits under all five: the person who adjusts receivables shouldn't be the same person who receives the cash. In a small agency that isn't always possible. When it isn't, the regular review of receivables is what stands in for it.

Who Should Have the Permission in the Software?

Only after the policy exists. Policy first, permissions second.

Once you've decided who's allowed to do what, make the software match. In most agency systems, creating credits, writing off invoices and posting them to the general ledger are separate permissions on a user's security group. Check who actually holds them today. You may find more people than you expected, including people who don't need them.

Workamajig's own guidance has a good example of why this matters. It warns against giving account managers the right to add and edit client invoices and credits, because with it, their "submit" becomes "approve" and they can generate invoices themselves. The same logic applies to credits: whoever can create one should have a reason in the policy to need it.

The software can enforce the policy. It can't write it for you.

What Do You Do About the Credit Memos Already on the Books?

Start with a report, not a reaction.

Pull every credit memo, write-off and void for the last twelve months. For each one, ask a single question: was the price actually reduced, or did the client just not pay?

Some of those invoices may still be collectible. Some may have gone to the client as an actual credit. Find out which before you change anything, and talk to your CPA before you touch a year that's already closed or a return that's already filed.

Then put the policy in place, so next year's report is short.

Who Is This Not For?

If you're a solo owner who does your own billing and your own collections, you already are the policy. Write it down anyway, because the day you hire help, it's ready.

And if you already approve every adjustment to receivables and review them regularly through the year, you're ahead of most agency owners I meet. Check that your software permissions still match what you decided.

Frequently Asked Questions

What's the difference between a credit memo and a write-off?

A credit memo reduces revenue, and a write-off moves an unpaid invoice to bad debt. Handled correctly, they have the same tax effect. Either one removes money your agency billed, so neither should happen without a written policy and someone reviewing it.

Who should be allowed to issue credit memos at an agency?

The bookkeeper can prepare it, but the owner, the CEO or one designated individual should approve every credit memo and write-off, with a written reason and a signoff. The person who adjusts receivables ideally shouldn't also be the person who receives the cash.

Can I deduct an unpaid client invoice as a bad debt?

Only if you already reported that invoice as income, which usually means you're on the accrual method for tax. Under the regulations, an unpaid fee isn't deductible unless the income was included on a return. Agencies on the cash method don't get a deduction, because the income was never reported.

When should an agency write off an invoice or issue a credit memo?

There's no rush. Make the decision when the data for your tax returns is ready to be finalized. If you've reviewed your receivables regularly through the year, that decision is a blip, because nothing on the list is a surprise.

Should account managers be able to issue credits?

Usually not directly. An account manager can request a credit with a reason, and the owner, the CEO or the designated individual signs off. Workamajig itself warns that giving account managers invoice and credit rights lets them approve and generate invoices on their own.

Your Books Should Only Change When You Decide They Change

Your humans are trying to help. A bookkeeper clearing old invoices thinks they're tidying up. Without a policy, though, tidying up and changing your numbers look exactly the same.

Write the one page. Match the software to it. Review your receivables through the year, and make the call when your tax data is ready to be finalized.

If you want more on running your agency by the numbers, I wrote a book for agency owners, and you can request a free copy at the link below.

Request your free copy

Nobody's looking out for your money but you. Let's go look together.

Craig S. Cody is a CPA, Certified Tax Coach, and retired NYPD Lieutenant. His firm works with more than 70 marketing and advertising agency owners every month, helping them keep more of what they make through proactive tax planning.

This article is general education, not advice for your specific situation. Confirm your own facts with your advisor before acting.