In finance, bad debt, occasionally called uncollectible accounts expense, is a monetary amount owed to a creditor that is unlikely to be paid and for which the creditor is not willing to take action to collect for various reasons, often due to the debtor not having the money to pay, for example due to a company going into liquidation or insolvency.
A high bad debt rate is caused when a business is not effective in managing its credit and collections process.
If the credit check of a new customer is not thorough or the collections team is not proactively reaching out to recover payments, a company faces the risk of a high bad debt.
Various technical definitions exist of what constitutes a bad debt, depending on accounting conventions, regulatory treatment and institution provisioning.
The reasons for potential non-payment can include disputes over supply, delivery, the condition of the item, or the appearance of financial stress within a customer's operations.
This is done to avoid over-stating the assets of the business as trade debtors are reported net of doubtful debt.
An example of a debt becoming uncollectible would be: once final payments have been made from the liquidation of a customer's limited liability company, no further action can be taken.
[3] Also known as a bad debt reserve, this is a contra account listed within the current asset section of the balance sheet.
[7] Because there is an inherent risk that clients might default on payment, accounts receivable have to be recorded at net realizable value.
At the end of each accounting cycle, adjusting entries are made to charge uncollectible receivable as expense.
[8] The actual amount of uncollectible receivable is written off as an expense from allowance for doubtful accounts.