What Is a Bad Debt Expense?

What Is a Bad Debt Expense?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A bad debt expense is a financial term. It refers to the amount of money that a company cannot recover from its debtors. Sometimes customers or clients borrow money from companies and fail to pay it back. When the company realizes that it can’t collect this debt, it categorizes it as a bad debt. This is then recorded as an expense in the company’s financial statement. It’s crucial for a business to take this into account as it impacts their profitability and overall financial health.

Related Questions

1. How is bad debt expense estimated?

Bad debt expense is usually estimated based on the previous history of uncollectible accounts. Companies could also use an aging schedule of accounts receivable, which organizes debtors according to the length of time an invoice has been outstanding.

2. Is bad debt expense tax deductible?

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Yes, in general, businesses can claim bad debt expenses as tax deductions. It is recognized as a business loss and can be used to offset taxable income.

3. How does bad debt expense affect income statement?

Bad debt expense increases a company’s expenses on its income statement. As expenses increase, net income decreases which results in lower reported earnings for the company.

4. Who bears the risk of bad debt expense?

The company who originally issued the credit bears the risk of bad debt expense. The risk intensifies if there is a sharp rise in the debtor’s default or inability to pay back the loan.

5. Can you recover a bad debt expense?

While it’s challenging, some bad debts can be recovered through methods such as debt collection, legal action, or selling the debt to a collection agency. However, it’s often seen as a last resort due to the time and cost involved.