Bad Debt - Meaning and Examples

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Debt Meaning

Debt is the amount of money that is borrowed by one party from another party. Debt is used by many corporations and individuals as a method of making purchases in a good quantifiable amount which they could not afford under any normal circumstances. A debt is an arrangement that gives the borrowing party permission to borrow money under the condition that the amount is to be paid back at a later date, also paid with an interest amount.

Debt Example

Debt is the owing money, the owed money which is due previously, or the feeling as if one owes someone or something. An example of the debt is what an individual owes on the mortgage and the car loan. An example of this debt is the feeling of gratitude when someone helps you to go to college for higher studies.

Example: To be in debt of thousand dollars.

Bad Debts Meaning and Examples

Bad debt is that debt that was previously receivable but now is irrecoverable from that person who was supposed to pay that debt. This means the debt becoming bad as it is unpaid. The reason for this non-payment may be the cause as the debtors either get bankrupted or have financial problems say the problem in the collection by the creditors for various reasons which are not possible. There are various definitions for bad debts to occur which will depend on the type of accounting.

Types of Bad Debts

There are types of Bad Debt that can be classified, although there are no set defined types of bad debt yet any business can incur the same.

We may classify the bad dents according to different types of business models in the following category -

  • Traders – A business entity that sells and purchases the goods on credit, might incur bad debts in case his or her customer didn’t oblige to the predefined sets of terms and conditions of the payment for the purchase of these goods.

  • Service Providers – Similarly for a trader, a service provider may also incur bad debt loss in case his or her client which do not repay the fees after utilizing the services, provided by the service providers.

  • Repayment of Loan – For a person who is engaged in providing the loans, if a receiver does not repay his or her dues, then this will also amount to bad debts.

  • Court Order – In case of a dispute where out of any judicial authority, an order is pronounced directing any party to pay another party but still if the party fails to repay, this will also lead to creating bad debts.

Provision for Bad and Doubtful Debts 

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The provision for the doubtful debts, which is also referred to as the provision for bad debts or even known as the provision for losses on the accounts of receivable, is further estimation of the amount of the doubtful debt which will need to be written off during a particular. This is a provision or an allowance for the debts which are assumed to be doubtful.

Allowance for Bad Debts

An allowance for bad debt is the valuation account that is used to estimate the amount of a firm's receivable which may later be ultimately uncollectible. This is also known as the allowance for doubtful accounts. When a borrower defaults on any loan, then the allowance for the bad debt account and the loan which is received is the balance that is both reduced for the book value of the loan amount.

Bad Debt Expense

A bad debt expense is recognized, at the time when a receivable is no longer collected as the customer is not able to fulfill their own obligation to pay the outstanding debt for the bankruptcy or other financial problems. The Companies which extend credit to their customers report these bad debts as an allowance for the doubtful accounts on the balance sheet, which also provides for credit losses.

Bad Debt Reserve

A bad debt reserve is the valued number of receivables that a company or financial institution does not intend to actually collect. This includes the business payments that become due and the loan repayments as well.

Bad Debts Written Off Meaning

The Debt which cannot be recovered, and also which cannot be collected from a debtor is the bad debt. The process is called writing off bad debt. Under the direct write-off method, the bad debts are shown as expensed. The company credits the accounts which is receivable on the balance sheet while debiting the bad debt expense account on the income statement.

FAQ (Frequently Asked Questions)

1. When Should Bad Debt be Written Off?

Ans. To record the bad debt expenses, we should debit the bad debt expense and give credit allowance for the doubtful accounts. This entails a credit to the Accounts Receivable for the amount which is written off and a debit to the bad debts expense account.

Bad debt can be written off using the direct write-off method or by the provision method. The first approach tends to delay the recognition of bad debt expense. This is necessary to write off the bad debt when related to the customer invoice that is to be considered to be an uncollectible debt.

2. What is Meant by Provision for Doubtful Debt?

Ans. The provision for doubtful debts is the amount that is estimated for the bad debt which will arise from the accounts receivable which have been issued but not still collected. This is identical to the allowance for the doubtful account. The provision which is used under the accrual method is that expense is recognized with probable bad debts as soon as the invoices are issued to the customers.

3. What is a Mortgage?

Ans. A mortgage is to use one's real property for a guarantee required for a loan to get the money. The debtor or the mortgagor owns the property, while the creditor or mortgagee is the owner who owns the loan. When the mortgage transaction is executed, the debtor gets the money with the loan and promises to pay the loan back.