What is classified as a bad debt?

A bad debt is specifically classified as an expense incurred when a debt is deemed irrecoverable. This typically occurs when a customer has failed to pay for goods or services received, and after reasonable collection efforts, the business concludes that there is no realistic possibility of collecting the amount owed.

When a company recognizes a bad debt, it must write off the receivable in its accounts, thus impacting its profit and loss statement. This entails recognizing an expense that reflects the loss of expected revenue. Understanding bad debts is particularly important for financial reporting and assessing the financial health of a company, as it directly affects income statements and balance sheets.

The other choices include scenarios that do not meet the criteria for bad debts. Recoverable debts, stock returns, and service contracts relate to other aspects of accounts management but do not signify irrecoverable debts, which are the defining characteristic of bad debts.