Bad Debt
A bad debt occurs when you owe money but fail to collect it. This type of debt takes place when you offer services or products on credit. There are some customers who require more time to repay the debt. However, there are some who will never pay the debt. The result of bad debt is that the money is lost as well as accounting becomes complicated. If you are utilizing accrual basis accounting, you have to acknowledge the income at the moment when it is sold and not the moment when it is repaid. A non paid sale becomes an overdue account due to the wastage of time. As you pass through the several collection routines, the overdue account finally is converted to a bad debt. Thus, you may not understand that there is a bad debt till the next tax year. The solution in accounting is to create an allowance for bad debts. You must match the bad debts against the sales at a time when the bad debt has gathered and make an estimate of the amount. The bad debts may be written off on the income tax. This is a good method for handling the bad debts issue.