What Is Bad Debt?
Bad debt is money owed to a business that it no longer expects to collect, so it's written off as a loss. It arises when a customer fails to pay an invoice and recovery becomes unlikely, turning a receivable into an expense.
What bad debt is and why it matters
Extending credit always carries the risk that some customers won't pay. Bad debt recognizes that reality by removing uncollectible receivables from the books and recording the loss. Under GAAP, businesses typically use the allowance method — estimating expected bad debt in advance based on aging and history, so the expense matches the period of the sale rather than the later moment of write-off. Tracking bad debt matters because it affects both the accuracy of accounts receivable and the true profitability of sales made on credit.
A worked example
A company estimates that 2% of its $200,000 in receivables won't be collected. It records bad debt expense of $4,000: debit *Bad Debt Expense* $4,000, credit *Allowance for Doubtful Accounts* $4,000. Later, a specific customer's $1,200 invoice is confirmed uncollectible; the company writes it off against the allowance: debit *Allowance for Doubtful Accounts* $1,200, credit *Accounts Receivable* $1,200. Net receivables and income already reflected the expected loss.
How firms handle it today
Firms review the aging report, estimate the allowance each period, and write off specific accounts once collection efforts are exhausted — a recurring judgment made at close.
Related terms
- Accounts receivable
- Aging report
- Write-off
- Net income
- Revenue
FAQ
What's the difference between bad debt and a write-off?
Bad debt is the concept of uncollectible money owed; a write-off is the accounting action that removes that specific receivable from the books.
What is the allowance method?
It estimates expected bad debt in advance and records it as an allowance, so the expense matches the period of the sale under GAAP.
Is bad debt an expense?
Yes — bad debt expense reduces net income in the period it's recognized.