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Bad Debt Reserve Definition
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.
A Little More on What is a Bad Debt Reserve
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 company’s 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.
Reference for “Bad Debt Reserve”
- https://www.investopedia.com › Trading › Trading Instruments
- https://www.wallstreetmojo.com › Accounting › Liabilities in Accounting
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.