longer be collected, typically from accounts receivable or loans. Bad debt in accounting is considered an expense. There are two methods to account for bad debt: Direct write off method (Non-GAAP): a receivable that is not considered collectible is charged directly to the income statement. Allowance method (GAAP): an estimate is made at the end of each fiscal year of the amount of bad debt. This is then accumulated in a provision that is then used to reduce specific receivable accounts as and when necessary. Allowance for bad debts are amounts expected to be uncollected but that are still possible to be collected (when there is no other possibility for collection, they are considered uncollectible accounts). For example, if gross receivables are US$100,000 and the amount that is expected to remain uncollected is $5,000, net receivables will be US$95,000. The matching principle of accounting calls for revenues and expenses to be recorded in the period in which they are incurred. When a sale is made on account, revenue is recorded along with account receivable. Because there is an inherent risk that clients might default on payment, accounts receivable have to be recorded at net realizable value. The portion of the account receivable that is estimated to be not collectible is set aside in a contra-asset account called "allowance for doubtful accounts". At the end of each accounting cycle, adjusting entries are made to charge uncollectible receivable as expense. The actual amount of uncollectible receivable is written off as an expense from allowance for doubtful accounts. Taxability Some types of bad debts, whether business or non-business-related, are considered tax deductible. Section 166 of the Internal Revenue Code provides the requirements for which a bad debt to be deducted. Section 166 Section 166 limits the amount of the deduction. There must be an amount of tax capital, or basis, in question to be recovered. In other words, there is an adjusted basis for determining a gain or loss for the debt in question. An additional factor in applying the criteria is the classification of the debt (non-business of business). Business bad debts Business bad debts are debts closely related to your business or trade. They are created or gained through transactions directly or closely related to your business or trade. A loss from a business bad debt occurs once the debt acquired or gained has become wholly or partly worthless. Bad business