bad debt

(noun)

A debt which cannot be recovered from the debtor, either because the debtor doesn't have the money to pay or because the debtor cannot be found and/or forced to pay.

Related Terms

Examples of bad debt in the following topics:

  • Valuing Accounts Receivable

    • These uncollectible accounts are called bad debts.
    • Companies use two methods to account for bad debts: the direct write-off method and the allowance method.
    • For tax purposes, companies must use the direct write-off method, under which bad debts are recognized only after the company is certain the debt will not be paid.
    • Recognizing the bad debt requires a journal entry that increases a bad debts expense account and decreases accounts receivable.
    • The adjusting entry to estimate the expected value of bad debts does not reduce accounts receivable directly.

  • Dealing with Foreign Currency and Bad Debts

    • To deal with foreign currency and bad debts, we have a "gain or loss" account and methods to measure the net value of accounts receivable.
    • The allowance for bad debt/doubtful accounts is a permanent account.
    • While the corresponding bad debt expense account is a temporary account that is zeroed out annually.
    • The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement .
    • Explain how the "gain or loss" account is used for foreign currency transactions and bad debts

  • Recognizing Notes Receivable

    • The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable.
    • The amount of the bad debt provision can be computed in two ways, either (1) by reviewing each individual debt and deciding whether it is doubtful (a specific provision); or (2) by providing for a fixed percentage (e.g. 2%) of total debtors (a general provision).
    • The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement.
    • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.
    • The two methods are not mutually exclusive, and some businesses will have a provision for doubtful debts, writing off specific debts that they know to be bad (for example, if the debtor has gone into liquidation. )

  • Activities to Manage Receivables

    • The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable.
    • The amount of the bad debt provision can be computed in two ways, either (1) by reviewing each individual debt and deciding whether it is doubtful (a specific provision) or (2) by providing for a fixed percentage (e.g. 2%) of total debtors (a general provision).
    • The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement.
    • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.

  • Valuing Notes Receivable

    • Notes Receivable represents claims for which formal instruments of credit are issued as evidence of debt, such as a promissory note.
    • The first method is the allowance method, which establishes a contra-asset account, allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable.
    • The amount of the bad debt provision can be computed in two ways:
    • by reviewing each individual debt and deciding whether it is doubtful (a specific provision)
    • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.

  • Classifying Receivables

    • Not all accounts receivables will be paid, and an allowance has to be made for bad debts.
    • The allowance for bad debts can be calculated either as the percentage of net credit sales or by the ageing method of estimating bad debts.

  • Write-Offs

    • This phenomenon is known, in the realm of accounting, as bad debt.
    • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.
    • The bad debt is recognized as an expense at the point when judged to be uncollectible.
    • When using the allowance method, an estimate is made at the end of each fiscal year of the amount of bad debt.

  • Recognizing Accounts Receivable

    • Since not all customer debts will be collected, businesses typically estimate the amount of and then record an allowance for doubtful accounts which appears on the balance sheet as a contra account that offsets total accounts receivable.
    • Two methods are available to calculate the amount of bad debt expense and allowance of doubtful accounts at the end of an accounting period -- percentage of accounts receivable or percentage of sales.
    • When accounts receivables are not paid, some companies turn them over to third party collection agencies or collection attorneys who will attempt to recover the debt via negotiating payment plans, settlement offers or pursuing other legal action.
    • To adjust the allowance account for the new estimate, debit Bad Debt Expense for USD 500 (10,000 *0.05) and credit Allowance for Doubtful Accounts for USD 500.
    • To adjust the allowance account for the new period's estimate, debit Bad Debt Expense for USD 2,000 (20,000 *0.10) and credit Allowance for Doubtful Accounts for USD 2,000.

  • Introduction to the Statement of Cash Flows

    • These non-cash transactions include depreciation or write-offs on bad debts or credit losses.
    • Financing activities includes all transactions related to changes in the amount of a business's equity available for sale or the amount of the business's outstanding debt, with the exception of interest payments.

  • Debt-to-Equity Ratio

    • The Debt-to-Equity Ratio is a financial ratio that compares the debt of a company to its equity and is closely related to leveraging.
    • The Debt-to-Equity Ratio is a financial ratio indicating the relative proportion of shareholder's equity and debt used to finance a company's assets, and is calculated as total debt / total equity.
    • Debt is typically a long-term liability that represents a company's obligation to pay both principal and interest to purchasers of that debt.
    • Calculating a company's debt to equity ratio is straight forward, and the debt and equity components can be found on a company's respective balance sheet.
    • For more advanced analysis, financial analysts can calculate a company's debt to equity ratio using market values if both the debt and equity are publicly traded.