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What is Bad Debt Expense?

Definition: Bad debt expense is a receivable that is no longer collectable, also called an uncollectable account. This can happen when a company allows a customer to put a purchase on credit. Just about every department stock and home improvement stock offers their own credit cards. This is kind of the same concept.

What Does Bad Debt Expense Mean?

What is the definition of bad debt expense? You might ask yourself why any company would want to sell to people on credit if they are going to have uncollectable accounts and be forced to take a loss on the sale. Most companies believe that consumers will buy more products if they have a credit. If you are anything like me, you know that is true. The company's rationale is that the total sales will increase so much that it will more than offset the cost of the bad debt. Since department and home improvement stores keep doing this year after year, I'm sure their theory is right. :)

Let's take a look at an example.

Example

The customer takes the inventory, charges the store credit card, and doesn't actually pay for goods when he leaves the store. The company assumes that the customer will repay the balance on his store credit card, so the company makes an account receivable for the customer. After trying to collect the balance from the customer, the company realizes that they will never be repaid this money.

The company has a few options like receivable to a collections agency, keep trying to collect it, or just write it off. When the company goes through all these steps and ends up deciding that they will never see this money again, the receivable from the customer becomes a bad debt and can be written off using either the direct write-off method or the allowance method.

Summary Definition

Define Bad Debt Expense: Bad debt expense is cost associated with removing a balance from a receivable when the customer refuses to pay and it is no longer able to collected.

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