There are many kinds of debt involved in lending, accounting, and bankruptcy. In this article, we’ll define the terms bad debt, bad debt expense, bad debt recovery, allowance for bad debt, nondischargeable debt, secured debt, and unscheduled debt.
Bad debt is an expense incurred by a business when the repayment of credit previously extended to a customer is considered uncollectible and can be recorded as a charge-off. It is a contingency that all businesses that extend credit to customers must account for, as there is always a risk that payment will not be made.
Bad debt expenses are the way businesses account for a receivable account that will not be paid either because the customer cannot pay or chooses not to pay. This may be because the customer cannot afford to pay or because they disagree about the product or service they were sold.
Bad debt recovery is a payment received for a debt that was written off as uncollectible. Bad debt recovery can be in the form of a loan, a line of credit, or any other accounts receivable. Because it generates a loss when written off, bad debt recovery usually produces income. Bad debt recovery credits the allowance for bad debts and reduces the accounts receivable category.
Allowance for bad debt, also known as allowance for doubtful accounts, is a valuation account used to estimate the number of a firm’s receivables that may not be collectible. Allowance for bad debt is used because the face value of a company’s total accounts receivable is not the actual balance that is ultimately collected. When a borrower defaults on a loan, the allowance for a bad debt account is reduced from the book value of the loan.
Secured debt is debt secured by a collateral to reduce the risk of lending. If a borrower of a loan defaults on paying it, the creditor can seize the collateral, sell it, and use it to pay back the debt. This protects the lender from bad debt. In the event of a company going bankrupt, secured lenders are paid back before unsecured lenders.
Types of collateral include: