What is "bad debt"?

Bad debt refers to amounts that a company has deemed uncollectible and has written off its books, often sending these amounts to collections. This typically occurs when the debtor has not made payments for an extended period, and the likelihood of recovering the owed amount diminishes significantly.

The identification of debt as "bad" often leads to a company recognizing a loss, which impacts its financial statements. Writing off debt is a necessary accounting practice to provide a more accurate representation of the company’s financial health and assets.

While other options describe different situations regarding debt—such as actively collected debt, secured debt with collateral, or debts with interest rates—none of them specifically align with the definition of bad debt, which is intrinsically linked to the decision to write off uncollectible amounts. Thus, recognizing bad debt is crucial for effective financial management and reporting.