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QuickBooks Tips Blog

How to Record a Settlement of Debt in QuickBooks

Posted by Alex Viau on Jan 11, 2013 6:02:00 AM

We all fall behind on our bills at one point or another in our lives but others may go a little further then that just like Han Solo. Forgoing payment to a particular vendor for an extended period of time may turn into  insurmountable debt. The debt may now become a loan, which will require you to record a settlement of debt in QuickBooks to help keep your books balanced. I hope for your sake though it never gets as bad as Han Solo.

The Scenario
Your company, ABC, has unfortunately been unable to pay back XYZ for a $1,000 monthly advertising bill that has now accumulated to $12,000 for the year.  XYZ wants their money. ABC knows that its cash flow just doesn’t warrant making a $12,000 payment to XYZ for the advertising bills now past due. A year has passed and those 12 bills still sitting in your Accounts Payable continue to show past due. You have a phone call with XYZ and an agreement is reached…

The Debt is Forgiven
The absolute best-case scenario for your business is that XYZ tells your company that those 12 bills for $12,000 on your books do not need to be paid. Well, how do I clear out my accounts payable in QuickBooks then to show the twelve bills as paid? Simple. Because XYZ has told you that those twelve are no longer due you've now just technically generated a new source of income. To record this transaction you:

1.)  Create a credit in the amount of $12,000 to XYX
2.)  The account on the credit you hit will be an “Other Income” account that I would call “Gain From Relief of Debt” … as the bill has technically ‘been paid’ with an income other than your businesses main form of income we book it as ‘other income’
3.)  Enter your accounts payable screen and set the $12,000 credit one bill at a time
4.)  Pay the bills you’ve selected once the credit has been applied to each bill
5.)  You now have on your books a $12,000 income for settling your debt

No Debt is Forgiven

The opposite of the above is that XYZ still wants their money in full but they’ve opted for a payment plan. XYZ will accept $400 a month for 3 years to pay off the total debt of $12,000 interest free. The bills in accounts payable must now be converted to a loan. To do this we apply the same principals as above:

1.)  Create a credit for $12,000 
2.)  This time hit a liability account that could be called “XYZ Settlement Loan” in the credit
3.)  Set the credits in accounts payable
4.)  Pay the bills with the credit
5.)  A loan will now show on ABC’s books for $12,000
6.)  Each month now for 3 years a check will be written to XYZ that will hit the “XYZ Settlement Loan” liability account until it is cleared

The Hybrid of the Two
The most common scenario I see is that XYZ will agree to a lesser portion of the debt so long as an agreement is made for the debt to be paid off in a timely manner. Generally, this occurs when a debt settlement company acts as a liaison between ABC and XYZ to broker a deal. They will charge fees to ABC but the savings for the most part can be well worth the cost.

The debt settlement company brokers a deal with XYZ and tells you that they have settled for ABC to pay only $6,000, sounds good! The terms are that the debt must be paid off in 1 year and $100 a month will be charged by the settlement company thus making a monthly payment of $600. Here’s the break down…

1.)   Again, create a credit for $12,000 to clear out the bills in accounts payable. Itemize the credit with $6,000 to an other income account called “Gain From Settlement of Debt” and a liability account called “XYZ Debt Settlement”
2.)   Set the credits in accounts payable for the bills and then pay the bills to clear them from Accounts Payable
3.)   You know have a loan for $6,000 and an income of $6,000
4.)   Every month for 1 year a check will be written for $600 to the settlement company acting as the liaison for ABC. Itemize the check with $100 to a Professional Fees expense and $500 to the liability account

Accounts Payable can be confusing and it’s often that most people take the easy road by just deleting their bills that are no longer owed. Not only will you create more headaches down the road for you, your bookkeeper, and CPA, you’ve now also changed your balance sheet for tax years prior that have already been filed!

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Topics: QuickBooks Tips, QuickBooks Tips Blog, Learning QuickBooks, learn QuickBooks, Personal Bookkeeping, Settlement of Debt, Debt Relief