bad-debt losses

(noun)

losses resulting from an uncollectible debt.

Related Terms

Examples of bad-debt losses in the following topics:

  • Setting a Credit Policy

    • A restrictive policy will most likely result in lower sales, but the firm will have a smaller investment in receivables and incur less bad-debt losses.
    • Less restrictive policies will generate higher sales as well as a higher receivables balance, but the company will most likely incur more bad-debt losses and a high opportunity cost of holding capital in accounts receivables.
    • Potential losses not only include the selling price, but can also include disruption to cash flows and increased collection costs.
    • Character: Is the borrower trustworthy with a history of meeting its debt obligations?

  • Collecting Receivables

    • A collection agency is a business that pursues payments of debts owed by individuals or businesses.
    • First-party agencies are oftentimes a subsidiary of the original company to whom the debt is owed.
    • Third-party agencies are separate companies contracted by a business to collect debts on their behalf for a fee.
    • A company may protect against bad-debts losses by purchasing trade credit insurance.
    • This is an example of a letter from a collection agency offering to settle a debt.

  • Regulatory Oversight

    • Basel committee wanted to ensure banks had enough capital to survive a financial crisis and avoid massive profit losses.
    • The Federal Reserve bought many of the toxic mortgage loans from the banks, removing the bad debt from their books.
    • Leverage, in our case, equals the ratio of debt a business uses to acquired assets.
    • Many banks accumulated debt to acquire properties at the peak of the housing bubble.
    • Once the bubble deflated, the property fell in value, and the banks could not sell it without enormous losses.

  • Extraordinary Gains and Losses

    • Extra gains or losses are nonrecurring, onetime, unusual, non-operating gains or losses that are recorded by a business during the period.
    • Extra gains or losses are the result of unforeseen and atypical events.
    • Net income is reported before and after these gains and losses.
    • As a result, extraordinary gains or losses don't skew the company's regular earnings.
    • Examples of extraordinary items are casualty losses, losses from expropriation of assets by a foreign government, gain on life insurance, gain or loss on the early extinguishment of debt, gain on troubled debt restructuring, and write-off of an intangible asset.

  • Debt

    • Debt is usually granted with expected repayment.
    • For both companies and individuals, this increased risk can lead to poor results, as the cost of servicing the debt can grow beyond the ability to pay due to either external events (income loss) or internal difficulties (poor management of resources).
    • A company uses various kinds of debt to finance its operations.
    • The various types of debt can generally be categorized into:
    • Treasury bills are one kind of debt issued by the U.S.

  • Corporate Fraud

    • The Enron Corporation declared bankruptcy in 2001 and became the universal symbol for corporate fraud.Enron managers created Special Purpose Entities (SPE) with the sole purpose to wipe debt and liabilities from Enron's financial statements.A Special Purpose Entity consists of a company or subsidiary of the corporation.A SPE could be a shell company, where the company does not physically exist, except on paper.
    • The Enron managers invested in many power plants around the world, and some of its investments soured and failed.Then, they created off-balance sheet companies, and they sold its bad investments to its SPEs.Afterwards, their balance sheet appeared financially strong, and Enron applied for more bank loans, gaining more cash.Next, the Enron management bought more companies, and they repeated the process.At the end, Enron hid $25 billion in debt from its investors.
    • Enron's managers invested Enron stock in the SPEs.As Enron's stock price soared, the SPE's finances remained healthy until Enron's stock price peaked at $90 per share.Once Enron's stock price began plummeting until it fell below one dollar per share in 2000, the SPEs earned substantial losses.Enron hid the losses and asked banks for more loans that would keep the company afloat, but Enron failed to obtain new loans.The U.S. economy entered a recession in 2001 after many internet companies bankrupted in 2000.A recession always exposes anorganization's weakness.Unfortunately, Enron employees' pension funds were invested in Enron stock, and many employees lost their pension funds and became unemployed.
    • The U.S. economy rebounded from the strong, overly optimistic real estate market.Everyone forgot Enron's misdeeds until the 2007 Great Recession, when the scale of fraud became much larger.For example, Lehman Brothers used exotic securities such as credit default swaps and collateralized debt obligations to buy real estate (Discussed in Chapter 18).After the recession had struck, unemployment doubled, and many households started defaulting on theirmortgages.Commercial and investment banks stopped lending overnight, and real estate prices began tumbling.Unfortunately, Lehman Brothers went on a spending spree, buying real estate toward the peak of the housing bubble.It held $768 billion in bank and bond debt while it had $639 billion in assets that dropped rapidly as real estate prices fell.Lehman Brothers filed for bankruptcy in 2008 and had closed its doors after 158 years of business.

  • Return on Common Equity

    • A company with a high ROE does a good job of turning the capital invested in it into profit, and a company with a low ROE does a bad job.
    • However, like many of the other ratios, there is no standard way to define a good ROE or a bad ROE.
    • Thus, a higher proportion of debt in the firm's capital structure leads to higher ROE.
    • So if the firm takes on too much debt, the cost of debt rises as creditors demand a higher risk premium, and ROE decreases.
    • Increased debt will make a positive contribution to a firm's ROE only if the matching return on assets (ROA) of that debt exceeds the interest rate on the debt.

  • Defining Accounts Receivable

    • The first method is the allowance method, which establishes an allowance for doubtful accounts, or bad debt provision, that has the effect of reducing the balance for accounts receivable.
    • The amount of the bad debt provision can be computed in two ways:
    • By reviewing each individual debt and deciding whether it is doubtful (a specific provision)
    • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.

  • Defining Financial Leverage

    • Financial leverage is a tactic to multiply gains and losses, calculated by a debt-to-equity ratio.
    • At its simplest, leverage is a tactic geared at multiplying gains and losses.
    • Debt is often lower cost access to capital, as debt is paid out before equity in the event of a bankruptcy (thus debt is intrinsically lower risk for the investor).
    • Let's say equity represents 60% of borrowed capital and debt is 40%.
    • The organization owes 10% on all equity and 5% on all debt.

  • Chapter Questions

    • Identify the changes to the monetary base and money supply if bad weather causes the float to increase.
    • Explain how the Federal Reserve can monetize the U.S. debt if the Fed and the U.S.