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A bad debt write-off is an accounting method that makes it possible to remove or write-off a debt that has been deemed to be uncollectable. Companies sometimes use this type of business write-off in order to correct the current accounts receivables after determining that a given debt owed by a customer will not be settled. Writing off uncollectable debt does not necessarily mean that some type of collection effort will not continue, or that the debtor is no longer responsible for the outstanding amount. Instead, it means that by classifying the debt as uncollectable, the business may be able to use that amount as a deduction on its taxes.
There are several situations in which a bad debt write-off may take place. The most common is when a customer defaults on an outstanding account balance. In this scenario, the vendor makes reasonable efforts to collect at least a portion of the debt. Should these efforts prove unsuccessful, the outstanding balance is declared uncollectable and that amount is no longer accounted for in the accounts receivables of the company accounting records. The bad debt is still tracked for the remainder of the tax year, and may be used as a deduction, depending on the tax laws that apply in the jurisdiction in which the company is located.
A bad debt write-off can also take place when a customer chooses to seek bankruptcy protection. Depending on the type of bankruptcy that is filed, the chances of collecting on the debt may be somewhat slim. In any event, the debtor bankruptcy will mean that contacting the customer directly in an attempt to collect the past due amount will no longer be an option. Moving forward, any possibility of realizing at least a portion of the debt will depend on the decision of the court that is overseeing the bankruptcy proceedings.
It is important to note that processing a bad debt write-off does not mean that no further efforts to collect the debt will take place. Many companies choose to write off the debt as a business expense, then turn the delinquent customer account over to a collection agency. Often, the agency takes on the task of attempting to collect, with the understanding that if successful, the agency will keep a specific percentage of the collected debt as compensation for their services. At other times, the business may choose to sell the bad debt outright to debt collection agencies, usually for some percentage of the total amount, then declare a bad debt write-off on the remaining balance on the sold account. That agency will then attempt to collect the entire amount plus interest that is applied as a means of generating some profit on the transaction.