Definition:

Bad-debt expense is the expense recognized on the income statement to account for the estimated amount of uncollectible accounts receivable. It’s a result of customers failing to pay their bills.

Key points about bad-debt expense:

  • Allowance method: The most common method for accounting for bad debts is the allowance method, which involves creating an allowance for doubtful accounts.
  • Direct write-off method: Another method, but less commonly used, is the direct write-off method, where bad debts are written off directly against the accounts receivable account.
  • Matching principle: Bad-debt expense is recognized in the same period as the related credit sales, following the matching principle.
  • Tax implications: Bad-debt expense can be deducted from taxable income, reducing a company’s tax liability.

Why is bad-debt expense important?

  • Financial statements: Bad-debt expense is reported on the income statement as an expense, affecting a company’s profitability.
  • Cash flow: Understanding bad-debt expense can help businesses manage their cash flow by anticipating potential losses from uncollectible accounts.
  • Credit policy: Bad-debt expense can be used to evaluate the effectiveness of a company’s credit policy.

In essence, bad-debt expense is the expense recognized on the income statement to account for uncollectible accounts receivable, and it’s an important factor in financial reporting and cash flow management.