A bad debt occurs when a company’s customers are unable to pay all or part of the amount owed, often due to factors such as bankruptcy. In accounting terms, a bad debt indicates that an invoice has not been paid, resulting in a potential loss for the business.
Defining bad debt
Bad debt is essentially any amount of money that a creditor must write off when a borrower defaults on loans.
This situation arises when the debtor, whether an individual or a business entity, displays no promise of repaying the borrowed amount, either partially or in full. When such debts become uncollectible, they are recorded as charge-offs.
When should invoices be written of as bad debt?
Several criteria must be met to write off an invoice as a bad debt:
- The invoice has been forwarded to debt collection, but payment has not been received.
- Twelve months have elapsed after the due date, and at least three reminders have been sent without resolution.
- The customer’s company has declared bankruptcy or undergone liquidation.
- A bankruptcy estate has been established for the customer, but there are no available funds.