BAD DEBT EXPENSE Meaning and
Definition
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Bad debt expense is an accounting term that refers to the cost incurred by a company due to customers' inability or unwillingness to fulfill their financial obligations. It is an expense recorded by a business entity when it becomes evident that a customer's outstanding debt is unlikely to be collected. Bad debt expense is recognized as a provision or an allowance for doubtful accounts, which is an estimate of the amount of bad debts expected in a specific period.
When a company extends credit to its customers, it assumes the risk that not all debts will be paid in full or at all. Bad debt expense is an acknowledgment of this risk and is recorded in the financial statements as an expense, thus reducing the net income of the company. It is usually treated as an operating expense and is subtracted from the gross sales revenue to obtain the net revenue.
The estimation of bad debt expense relies on historical data, industry standards, and the company's past collection experience. Companies often establish a bad debt reserve or allowance for doubtful accounts to account for potential non-payment by customers. This reserve is adjusted periodically, taking into account changes in the customer base, economic conditions, and other relevant factors.
Bad debt expense is crucial for accurate financial reporting as it reflects the impact of credit risk on a company's profitability. It helps businesses anticipate and plan for potential losses associated with credit sales, ultimately ensuring the accuracy and reliability of the financial statements.
