Certified Financial Management Specialist Practice Exam

Which of the following best defines bad debts in a financial context?

1. Payments received after a due date

2. Accounts that are collectible

3. Uncollectible accounts that can be deducted

4. Accrued income that is not yet paid

The correct answer is: Uncollectible accounts that can be deducted

In a financial context, bad debts specifically refer to uncollectible accounts that a business recognizes as unlikely to be collected. These are amounts owed to a company that are considered to be uncollectible due to various reasons, such as the debtor going bankrupt or failing to fulfill their payment obligations. When a business identifies a receivable as a bad debt, it typically allows for the deduction of that loss from taxable income, which can have implications for the business's overall financial health and tax obligations. The identification of bad debts is crucial for accurate financial reporting and assessment of a company’s receivables. A business may establish an allowance for bad debts as part of its accounting practices to anticipate and mitigate the impact of such uncollectibles on its financial statements. Recognizing bad debts helps maintain a realistic view of potential cash inflows. The other options do not accurately capture the essence of bad debts in this context. Payments received after a due date refer to late payments, while accounts that are collectible are the opposite of bad debts. Accrued income that is not yet paid pertains to income that has been earned but not yet received, which is unrelated to the concept of bad debts.