A net charge-off is a figure that identifies the difference between the total or gross charge-off of a delinquent account and any receipts on that account that are received after the charge-off has occurred. This type of situation usually arises when a customer account has been charged off as a bad debt, and later some type of payment against that debt is received by the company. The funds are received and recorded in the accounting books by noting the gross charge-off and applying the payment received, leaving a net charge-off remaining.
The possibility of a net charge-off occurring is relatively common in a number of business settings, with companies such as banks, loan companies, office supply firms, credit card providers, and even some retailers experiencing situations in which delinquent debt may be accumulated with a customer. Many companies will charge-off delinquent amounts as a way to clear the defaulted accounts from the accounting records, then turn over those accounts to a debt collector. Should the collector be successful in collecting the debt, a percentage is deducted as the commission for the collector and the remainder forwarded to the company. The company then deducts the amount collected from the total that was written off, resulting in a net charge-off rather than the original gross charge-off.
While a net charge-off may refer to a single customer account, the term is also used to describe the current status of delinquent accounts that have been written off, but that have received some type of payments during the latest accounting period. In this application, the company will look at the cumulative amount of bad debt charged off, with those totals representing the gross charge-off for the business as a whole. Any payments received for bad debt accounts are applied accordingly, adjusting the amount of charge-offs that remain. Tracking this type of activity accurately is very important, since revenue agencies in many nations allow businesses to obtain some sort of tax breaks for any bad debt that is charged off during the tax year.
The mechanisms used to track net charge-off activity will vary, depending on the accounting methods used by the business. One approach is to create and maintain a bad debt ledger that provides a quick and easy way to keep track of the bad debt accumulated over the course of the tax year, including any payments that may be received after the debt is written off. With many accounting software packages today, it is relatively easy to mark a customer account as bad debt, using the features in the software to easily generate reports that show all write-offs as well as any payments on those debts that are collected at a later date. The method used to track bad debt will often depend on how likely a given company is to experience this type of activity, with businesses that are more prone to bad debt typically using more comprehensive tracking measures than companies who may have no more than one or two accounts to write off in a given tax year.