What are bad debts?

Bad debts refer specifically to accounts receivable that are deemed uncollectible. This situation arises when a business has extended credit to a customer, but the customer is unable to fulfill their payment obligations. When a debt is considered "bad," it means that it is unlikely the company will receive payment, impacting the company's financial health.

Recognizing bad debts is important in accounting, as it affects the financial statements by reducing the total accounts receivable and potentially impacting income calculations, particularly if the business must write off these debts. Bad debts are typically assessed and written off based on historical data and specific customer circumstances.

In contrast, short-term investments, high-interest loans, and equity securities do not reflect the concept of bad debts. Short-term investments refer to liquid assets that can be converted into cash within a year. High-interest loans relate to the borrowing aspect and do not address collectability issues. Equity securities represent ownership in a company, and their value is not determined by collectability but rather by market performance. Thus, the definition and implications of bad debts specifically align with accounts receivable that are uncollectible.