Bad Debt Reserve - Explained
What is a Bad Debt Reserve?
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Table of ContentsWhat is a Bad Debt Reserve?How is a Bad Debt Reserve Used?Academics Research on Bad Debt Reserve
What is a Bad Debt Reserve?
A bad debt reserve refers to the dollar equivalent of the accounts receivable that are uncollectible in a company. The value of accounts receivable that a company does not expect to collect is the bad debt reserve. An allowance for doubtful accounts (ADA) is the same thing as a bad debt reserve. It is the reduction in the accounts receivable of a company due to defaults on loan repayments and credit losses.
Back to: ACCOUNTING, TAX, & REPORTING
How is a Bad Debt Reserve Used?
An estimate of a company's accounts receivable that can no longer be collected due to defaults on loan repayments is known as a bad debt reserve. A company can benefit from a bad debt reserve in two major ways. First, a company can state the face value of its loans or accounts receivable using a bad debt reserve. Second, a company stands the change to benefit a margin for error when it comes to planning of cash flows through a bad debt reserve. A bad dent reserve automatically reduces the accounts receivable on a company's balance sheet. That is, if some loans or accounts receivable are in default, the amount will be deducted from the total money a company is expecting to receive. For example, a company that has a total amount of $5,000 and accounts receivable and one of its customers has a loan default of $500, this amount will be deducted from the company's accounts receivable, it will be recorded as a bad debt. In accounting records or entry, the amount that a company keeps as bad debt reserve is determined by the company's management and the nature of the industry. A percentage of sales or historical average can also be used to estimate a bad debt expense in a company. Due to the tendency of some customers to default on loan repayments, many companies keep a bad debt reserve. A bad debt reserve that a company has can be used by financial analysts to track the financial wellness of a company as well as impending financial problems. The efficiency of a companys management to monitor the credit it offers to its customers determine the amount the company will have as its bad debt reserve. Offering credits to insolvent customers can tremendously increase a company's bad debt reserve which will in turn negatively affect its cash flow.
Academics Research on Bad Debt Reserve
- The Tax Treatment of the Reserve for Bad Debts on Incorporation: The Supreme Court Resolution in Nash, Raskind, L. J. (1970). The Tax Treatment of the Reserve for Bad Debts on Incorporation: The Supreme Court Resolution in Nash.Ohio St. LJ,31, 411.
- The Deduction for Bad Debts: A Study in Flexibility and Inflexibility, Ohl, J. P. (1969). The Deduction for Bad Debts: A Study in Flexibility and Inflexibility.The Tax Lawyer, 579-599.
- Bad Debt Reserves for Banks, Vernon Jr, W. (1948). Bad Debt Reserves for Banks.Tax L. Rev.,4, 53.
- The Bad Debt Reserves of Financial Institutions, Schoeneman, C. W., & McCoy, J. J. (1969). The Bad Debt Reserves of Financial Institutions.Wm. & Mary L. Rev.,11, 797.