bad debt

Updated on: 26 Jul 2017

Definition of bad debt

:loans that will not be repaid
  • banks with millions of dollars of bad debt

Word by Word Definitions

bad play
  1. : failing to reach an acceptable standard : poor

  2. : unfavorable

  3. : not fresh : spoiled

  1. : something that is bad

  2. : an evil or unhappy state

  3. : fault

  1. : badly

debt play
  1. : sin, trespass

  2. : something owed : obligation

  3. : a state of being under obligation to pay or repay someone or something in return for something received : a state of owing


Financial Definition of BAD DEBT

bad debt

What It Is

In business, bad debt is the portion of a loan or portfolio of loans a lender considers to be uncollectable. In personal finance, bad debt generally refers to high-interest consumer debt.

How It Works

For example, let's say Company XYZ manufactures bicycles and sells them through retail stores. Once the retailer receives the bicycles it has 90 days to pay Company XYZ. Company XYZ records the amount due as "accounts receivable" on the balance sheet and recognizes the revenue. However, as the 90 day due date passes, Company XYZ realizes the retailer is not ever going to make its payment.

Once it determines that it's a bad debt and won't be repaid, XYZ must make adjustments to its financial statements. Under accrual accounting, since revenue was already credited for the sale of the bicycles, Company XYZ must adjust its income statement for the bad debt. Therefore, Company XYZ has accounts for both allowance for doubtful accounts (ADA) and bad debt expense, which reduces the amount of net income reported by Company XYZ.

Companies have bad debt expense accounts because it is inevitable that some customers won't pay for the goods and/or services provided, usually occurs because the debtor declares bankruptcy.

For individuals, bad debt refers to debt that is not beneficial in the long run. While a mortgage is a form of debt, it is not considered bad debt, because the borrower has the potential to actually profit from an increase in their home's value. However, credit card debt and other forms of consumer debt are called bad debts, because they are debts taken on for consumption. Consumer goods almost always go down in value over time, so it's common to owe more on a credit card than the purchased goods are actually worth.

Why It Matters

Bad debt, when it applies to transactions between companies, is an inevitable part of doing business. Ultimately, not all payments owed to a company will be paid, so all companies have accounts for bad debt expenses and allowance for doubtful accounts (ADA). Therefore when investors and other outside people evaluate a company based on its income statement, the figure for net income has already been adjusted for bad debt.

Bad debt that applies to individual consumers is a term for debt that is harmful to consumers. The harm can ultimately be reflected in the individual's credit score. Bad debt is a signal to creditors that an individual is at a higher risk for not being able to repay debt, so it is harder to acquire loans the more bad debt a consumer has.


Law Dictionary

bad debt

legal Definition of bad debt

see debt

Learn More about bad debt


Seen and Heard

What made you want to look up bad debt? Please tell us where you read or heard it (including the quote, if possible).

Love words? Need even more definitions?

Subscribe to America's largest dictionary and get thousands more definitions and advanced search—ad free!

WORD OF THE DAY

alert quickness of mind or body

Get Word of the Day daily email!

Test Your Vocabulary

Merriam-Webster's New Words Quiz—Fall 2017 Edition!

  • young-plant-shoots
  • Which of the following is a new sense of the word bunny?
Name That Thing

Test your visual vocabulary with our 10-question challenge!

TAKE THE QUIZ
SCRABBLE® Sprint

Test Your Knowledge - and learn some interesting things along the way.

TAKE THE QUIZ

Love words? Need even more definitions?

Subscribe to America's largest dictionary and get thousands more definitions and advanced search—ad free!