Business Glossary

accepted way to account for bad debts. Bad debt expense may be based on the percent of credit sales for the period, an aging of the accounts receivable balance at the end of the period, or some other method (e.g., percent of accounts receivable). The allowance method results in a good matching of bad debt expense against sales. The journal entry at year-end to record anticipated uncollectibility of accounts receivable is to debit bad debts and credit allowance for bad debts. When it is known that a customer will actually not pay the balance, because of bankruptcy, for example, the entry is to debit allowance for bad debts and credit accounts receivable. If for whatever reason the customer does pay at a later date, there is a recovery; reverse the last entry and make a second entry debiting cash and crediting accounts receivable. It should be noted that firms other than small financial institutions are required to use the direct write-off method for tax purposes.

mutual agreement by borrower and lender to reschedule loan payments, modify payment terms by extending the original maturity, and so on. This normally is done in lieu of foreclosure action, in which the lender attempts to sell at auction any loan collateral pledged by the borrower. Loans in this stage of negotiations already are covered fully by loan loss reserves and have been writtenoff asbad debt. By negotiating new terms with the borrower, the lender expects to collect more from recoveries than from legal remedies, such as foreclosure, liquidation, and bankruptcy.

real estate acquired by a lender through foreclosure in satisfaction of a debt and held in inventory until sold. A loan secured by foreclosed real estate is counted as a Nonperforming Loan in reporting loan quality in call reports to bank supervisory agencies. Foreclosed real estate normally is auctioned off through a bidding process. Normally, the lender bids what is owed, and no more. If there are no higher bids, the lender takes the property and it becomes real estate owned. Also called other real estate owned (OREO).