A bad debt can be defined and explained as an amount which has been written off by the business as a loss and categorized as an expense for the debt owed to the business cannot be collected and all efforts made for the same have failed to collect the owed amount. A bad debt generally occurs when the debtor declares bankruptcy or even in cases when the cost of pursuing further action in an attempt of collecting the debt goes beyond the debt itself.
Explanation of bad debt by Investopedia
Many companies make sales on credit for it helps them in increasing the level of their sales, albeit some sales are made to the customers with less advantageous credit. Whilst some creditors demand more time to make the payments, there are others which never pay their dues. Companies not making credit sales are likely to estimate the amount expected to lose to bad debt, which is thereafter found in the stipend for doubtful accounts.
Any debtor with a record of bad debts will find a decline in the credit ratings thereby making it difficult for the debtor to way in any additional kind of credit.
Effect on taxability
Some of the bad debt expenses, either related or not related to business, are considered as tax deductible. The qualifications that form the criteria for a bad debt to be tax deductible are:
- should be worthless within a taxable year, and
- should be a bona fide debt.
Effects of bad debts
Bad debts, undoubtedly, affect the business. In addition to costing money to a business, these bad debts also affect the accounting process by making it all the more complicated. This is because it is important to recognize the income at the point when sales are , made and not when it actually comes in. due to the delay in payments, the non-paid sale becomes an overdue account thus leading you to go through different collection procedures. The overdue account, however, turns into a bad debt without your realization of it until a tax year later.