What is Bad Debt Expense?

The bad debt expense is recorded when an account receivable is written off, or as a result of a bad debt reserve calculation. Whenever a business sells goods or services on credit, there is a good chance that it will incur some amount of bad debt expense. The typical business will have a possibly substantial bad debt expense on its income statement. However, there are cases where the bad debt expense can be negative, where it actually increases the amount of reported profit. While this situation is rare, it can arise under the circumstances noted below.

Reasons for a Negative Bad Debt Expense

If uncollectible accounts receivable are being written off as they occur (the direct charge-off method), then there will be times when a customer unexpectedly pays an invoice after it has been written off. In such a case the correct treatment is to reverse the write-off, which will yield a negative bad debt expense if the original write-off occurs in a month earlier than the reversal.

On the other hand, if the allowance method is being used and an estimated amount is charged to bad debt expense each month, an unexpected customer payment may not result in a reversal of the original bad debt expense. Instead, since the assumption behind the allowance method is that some receivable will not be collectible (we just don't know which one), the accountant would normally not reduce the balance in the allowance for doubtful accounts.

Thus, the method being used to record bad debts will be the key determining factor in whether or not a business will ever experience a negative bad debt expense.

Example of a Negative Bad Debt Expense

A business issues an invoice for $500 to a somewhat problematic customer. After two months, the company’s controller assumes that the customer will not pay and writes off the invoice, resulting in a bad debt expense of $500 in the month of March. In April, the company receives full payment from the customer. Accordingly, the controller reverses the bad debt expense, resulting in a negative bad debt expense of $500 in the month of April. When the March and April income statements are netted together, the net amount of bad debt expense recorded for this customer is zero.