Bad Debt

Bad debt is the amount of receivables that can not be collected. Bad debt is considered as an expense in accounting.

What is Debt?

Before starting, we need to understand the term debt. Debt is created when a creditor or a lender agrees to lend some amount of money or assets to a debtor or a borrower.

How does one incur bad debt?
When a debtor or a borrower fails to return the money or assets to the creditor, bad debt happens.

The term Bad Debt means:

An account that is not collectible is considered as bad debt. In finance or accounting, bad debt is reported on the income statement as Bad Debts Expense or Uncollectible Accounts Expense.

When you provide some money or some services on credit, but are unable to recover the payment partially or fully, that's when bad debt occurs. Bad debt is worthless for the creditor and is thus written off by the company.

There are two accounting techniques to determine bad debt

Direct write off method - an amount of uncollectible receivable is charged directly to the income statement. That means uncollectible debt is deducted from the revenue in the accounting period in which they are recognized as uncollectible, not when the sale occurred. This method is completely based on facts, but it doesn't conform to the matching principle of costs to revenue. So it is not appreciated much.
Allowance method - In this method, you have to anticipate your income at the time of sale, not when it actually occurs. Because it is not necessary that you will recover the entire amount from the client. And this doubtful amount cannot be realized for a year. So an estimate is made of the uncollectible amount as soon as sale is recorded and is termed as Allowance for Doubtful Accounts. Then, the revenue is presented on the balance sheet with a reduction of this allowance for doubtful accounts. So this way, both revenues and expenses are recorded, when they occur. This method is the most accepted.

Other things which are considered as bad debts :
There are other factors also, which identify bad debt differently. You might be doing all your payments on time, but some of your expenses can put you in bad debt. If you take a debt to finance things for the purpose of consumption, it will bring you bad debt. If you use debt to purchase something that will increase in value like a house; this type of debt will be considered as favorable. But it's always good to avoid any sort of debt.

Debts, which are mostly considered unfavorable or bad

Credit card debt
Car loan
Debt to pay for vacation

Having bad debt tarnishes the debtor's credit rating. If a debtor is having series of bad debts, then it will become difficult to avail any sort of credit.

So you should make wise decisions when you are considering a debt. And also, try to make a balance between your earnings and your expenditures.