Bad debt accounting

[@TheFinanceStoryteller]

Enjoyed this video? Then please subscribe to the channel, and watch the related video on accounts receivable Days Sales Outstanding (DSO): kzbin.info/www/bejne/mqaxYXV3jp6EbtU

[@johnsuperhist5219]

Does it go to income statement or statement of financial position

[@dadadoobadoo4671]

Thank you SO MUCH! Excellent explanation, nothing unnecessary and everything so well-thought. I ligid was working on the bad debt chapter by myself for 2 hrs and still didn’t get it, and after one video it’s all so clear to me.

[@TheFinanceStoryteller]

That is wonderful to hear!!! Happy to help. Have a look at the related video on DSO (Days Sales Outstanding) as well: kzbin.info/www/bejne/mqaxYXV3jp6EbtU And please spread the word about the channel!

[@mohsinbaig2195]

Now this channel gonna help me to pass my semester exam ✌🏼♥️✨.

[@TheFinanceStoryteller]

You can do it! :-)

[@KrishanSingh-gz9op]

At 6:06 You didn't write $8 in debit of "bad debt expense", Does that mean that bad debt account gets cleared once we display it in income statement as a loss.? Or Does it mean that it becomes cleared (zero) by transferring the $8 to the credit side of allowances to doubtful debt.?

[@TheFinanceStoryteller]

As the header of the section clearly states, this section of the video deals with the balance sheet side of processing a write-off after an allowance was booked.

[@brofessor4803]

This is amazing. The textbook makes it so much more complicated than it has to be. Are you dutch by any chance?

[@TheFinanceStoryteller]

Thank you very much for the kind words! Please share with fellow students. 🙂 And yes, I am Dutch, but don't hold it against me. ;-)

[@SPEEDBOAT40PS]

WOW, that was fast! thank you so much!

[@TheFinanceStoryteller]

You're welcome! I am doing a 30-day KZbin challenge (1 video per day for 30 days), so any good topic suggested gets considered. :-)

[@SPEEDBOAT40PS]

@@TheFinanceStoryteller aha that sounds interesting! While studying I will look out for new topics you could cover in your videos 😉

[@TheFinanceStoryteller]

Deal! :-)

[@SPEEDBOAT40PS]

Hey, what about stock options and stock options expense? And also OCI? This video about bad debt expense was great BTW!

[@TheFinanceStoryteller]

Thanks for the suggestions! Stock options, stock option expense, and OCI, are not really topics where I already have the expertise to make a video, nor feel the energy to research it. I prefer "operational finance" topics like bad debt accounting, financial ratios, and practical finance topics like sunk cost. Still making a lot of new videos, hope that some of them might be helpful and/or entertaining for you!

[@trangha2330]

Thank you so much for your information. I have a question: does a decrease in bad debt ratio always necessarily mean an increase in credit quality?

[@TheFinanceStoryteller]

That's an interesting question. I am trying to find situations where that statement would not be true, but can't immediately come up with any, which doesn't mean they don't exist at all....

[@trangha2330]

@@TheFinanceStoryteller hehe thank you so much for replying! I was asking for my brother's midterm exam. And we haven't figured the answer out yet! Thank you so much for reading the comment and spending time replying, if I ever got the answer, I would let you know..

[@KrishanSingh-gz9op]

At 6:40 , Before $5 write off, allowances credit balance was $8, & after write off allowances credit balance was $3 ($8-$5). Similarly, can you tell me what will be the debit & credit balance in "Bad debt expense" before and after the $5 write off?

[@TheFinanceStoryteller]

The bad debt expense in the P&L is not impacted by this write-off journal entry.

[@KrishanSingh-gz9op]

2:58 you said that moving balance from accounts receivables to bad debt expense account is a very painful step for the company. Isn't allowances for bad debt painful too? They look same to me. The only difference to me is that bad debt expense is a "debit" account & allowances is a "credit" account? Why not simply write off by transferring balance to the bad debt expense account, instead of transferring balance to "allowances for bad debt"? (And in case if we recovered the written off account, we will show that in the income statement as recoveries?) So what's the need for allowances for bad debt account? Is there any benefit for transferring money to allowances for bad debt account instead of "direct write off -bad debt expense account"?

[@TheFinanceStoryteller]

The benefit is that in the general ledger you can continue to trace the original "gross" amount of the invoices in accounts receivable, and the allowance, separately. Subtract the latter from the former, and you have the net amount. Just like you would record the original purchase amounts for fixed assets in one account, and then accumulated depreciation in another.

[@KrishanSingh-gz9op]

@@TheFinanceStoryteller why can't we do the same with bad debt expense account?. i.e. subtract bad debt expense from total receivables to get net receivables

[@TheFinanceStoryteller]

The bad debt expense account is in the income statement, its balance gets reset to zero at the start of every new accounting year.

[@user-bj1ox3hu8v]

Great video, thank you. You mentioned on the end of this video fictive invoices. Invoices which a company issue knowing that they will never be paid. Is a fraud when children companies are invoicing to their mother company, knowing that mother company cannot pay, because there is any turnover or other business profitable activities by mother company? As result, the mother company is in a positive ‘Net Worth’ as there is shown a Total Current Asset.

[@TheFinanceStoryteller]

Thank you for the feedback and the question. If a "child" company invoices to the "mother" company for services rendered, the "child" company would book debit Accounts Receivable (intercompany), and credit Revenue (intercompany). the "parent" company would book debit Expenses (intercompany), and credit Accounts Payable (intercompany). The "child" company generates income with these entries, the "parent" generates a loss. When preparing consolidated financial statements, these entries would be eliminated. To detect fraud, the question is whether there is any economic substance that underlies the invoices issued. Does that help?

[@sumankhadka9781]

Trial Balance contains following information:Bad debts Rs.2000.Provision of Doubtful Debts Rs.1500.It is desired to make a Provision of Doubtful Debts Rs.2000 at the end of the year.Can you please make video over this.How should i pass journal entry for this kind of problem.

[@TheFinanceStoryteller]

Hello! That's not a topic/question that I plan to make a separate video for. The information in my "bad debt accounting" video should be sufficient to work this out.

[@chibuezedaike9331]

You debit bad debt expense with the difference and Credit Provision for doubtful debt as well with the difference to increase it...I hope this helps @sumankhadka9781

[@danschneider6466]

For "releasing the doubtful debt allowance", is that what happens when there is an amount left in the balance at the end of the period, so you clear it out as income and then calculate a new amount for the next year, or is that releasing itself the calculation for the new allowance?

[@TheFinanceStoryteller]

Hello Dan! The amount that is needed in the "allowance for doubtful debt" on the balance sheet at the end of a reporting period is directly related to the amount of "accounts receivable" on the balance sheet, and these in turn are generated from sales during the period (and prior periods). You could record changes to the "allowance for doubtful debt" in terms of journal entries in two ways: 1) release the old amount that was there on the balance sheet, and then record a new amount based on your latest calculation, or 2) book the increment (increase/decrease) versus what is already there. In both cases, the outcome of the entries could be that the new balance in "allowance for doubtful debt" is zero, if your analysis and calculations justify this, and this would constitute a "full release". In the video, I am simply talking about a situation where the quality of the accounts receivable balance increases (i.e. the risk of not collecting is now minimal), and the old balance that is there was based on a more negative outlook on collectability. In that case, part or all of the "allowance for doubtful debt" can be reduced, and the offset is a gain in the P&L.

[@danschneider6466]

@@TheFinanceStoryteller is it true that the first method, releasing the balance is for the income statement method, while booking the increment is for the balance sheet method.

[@TheFinanceStoryteller]

Can't tell, I am not familiar with that terminology.

[@danschneider6466]

@@TheFinanceStoryteller can we release the balance of allowance for doubtful debts and record a new amount if we're using the balance sheet method

[@TheFinanceStoryteller]

Please see my earlier answer. I can't tell, I am not familiar with that terminology.

[@chingchingma1252]

great explanation!!

[@TheFinanceStoryteller]

Thank you very much! Glad you like it. The related video on DSO might be useful for you too: kzbin.info/www/bejne/mqaxYXV3jp6EbtU

[@KrishanSingh-gz9op]

What is write back? For eg. "Provision for doubtful debts / loans and advances written back". What does it mean?

[@TheFinanceStoryteller]

Hi Krishan! I think it's the reversal of the provision. To write off is to take a hit because you are no longer expecting to collected a receivable. To write back sounds like the opposite: the receivable turns out to be collectable after all, so the provision you took in the past can be reversed.

[@KrishanSingh-gz9op]

As increase (credit) in "allowances for doubtful account" means that money may not be recovered & also it means reduction in net accounts receivables. So What does decrease in credit balance (right side) OR Increaee in debit balance (left side) in "allowances for doubtful account mean? Does it mean write off? Or does it means that amount is getting recovered?

[@TheFinanceStoryteller]

If you watch the video carefully, you will see that debits to the "allowance for doubtful debt" account can be either due to full write off (equal amounts disappear from the A/R balance and the allowance), or the situation on collectability has improved and the balance in the allowance can be lower (leading to "good news" on the expense side, negative bad debt expense for the period).

[@KrishanSingh-gz9op]

After $5 write off :- Accounts receivables = 40-5 = 35 & allowances (credit) balance = 8-5 = 3 Will the accounts receivables & allowances (credit) balance remain the same after the recovery? i.e. post $5 Recovery:- Account receivables = 35 +5 (increases when customer decides to payback) -5 (decrease due to cash received) = 35 Allowances for doubtful debt = 3 +5 (increase when customer decides to payback) -5 (decrease due to cash received) = 3.

[@TheFinanceStoryteller]

Yes, the accounts receivable and the allowance balances on the balance remain the same. In the very unlikely event of receiving cash from a bankrupt customer after an amount was written off, you debit cash and credit bad debt expense.

[@KrishanSingh-gz9op]

@@TheFinanceStoryteller But I think that in case of reverse write off (recovery) "allowances for bad debt" balance will be =3 +5 (reverse write off) = 8

[@TheFinanceStoryteller]

If you recovered the cash already, then why should you keep the allowance that high?

[@KrishanSingh-gz9op]

@@TheFinanceStoryteller They will increase because I have recovered the cash. Otherwise I will end up inflating my balance sheet. Moreover, allowances balance will only decrease in case of write off, so therefore during reverse write off allowances balances have to increase by the amount recovered. Otherwise it will mean that I have reduced allowances for recovered cash. Which will make no sense. You can see the table 5 of the following link:- corporatefinanceinstitute.com/resources/knowledge/accounting/allowance-for-doubtful-accounts/

[@TheFinanceStoryteller]

I am not going to start correcting other people's work.... the author at CFI misses the point in the "Example of Recovering an Account" section that there needs to be a credit to the income statement in bad debt expense.

[@Mhmd_Owais]

Really helpful 👍

[@TheFinanceStoryteller]

Glad to hear that, Owais!

[@KrishanSingh-gz9op]

We know that when we write off receivables we credit - receivables & debit - allowances for bad debt. Now, I will divide my question into two cases. Case 1:- what if the customer whose balance is written off pays back cash after the write off. As per the show example $5 was written off amount , & $8 was total allowances for doubtful debt. What will be the allowances for bad debt's credit balance if we get the $5 cash from written off customer.? Case2:- what if the customer pays $5 even before the write off? Then what will be the allowances balance? Will the adjustment entries for recovery (before & after the write off) will be the same in both the cases for - accounts receivable , allowances for bad debt, & cash balance?

[@TheFinanceStoryteller]

In the very unlikely event of receiving cash from a bankrupt customer after an amount was written off, you debit cash and credit bad debt expense.

[@MeditationsOfTruth]

@@TheFinanceStoryteller I thought we had to debit cash and credit Allowance for doubtful Accounts (instead of crediting bad debt expense)

[@chibuezedaike9331]

@@MeditationsOfTruth this is incorrect

[@chibble3591]

So is the allowance for doubtful debt a liability?

[@TheFinanceStoryteller]

Contra-asset account. See also: kzbin.info/www/bejne/n6nOlamFiZyNeqs

[@dungle-yc6hl]

Very good and funny videos bring a great sense of entertainment!

[@TheFinanceStoryteller]

Thank you! That's exactly what I am aiming for.

[@KrishanSingh-gz9op]

What is the difference between allowance for doubtful account & bad debt account? Is it similar to provisioning? Didn't understand the accounting of allowances for bad debt? Does bad debt expense means write off? Does allowance doubtful debt account means that company hopes that it will recover the money in the near future?

[@TheFinanceStoryteller]

Bad debt expense is in the P&L, allowance for doubtful debt is a contra-asset account on the balance sheet.

[@KrishanSingh-gz9op]

@@TheFinanceStoryteller But what is the difference between the two accounts? I only know that if I am going to lose money from accounts receivables, then I have to make bad debt expense account OR allowances for bad debt account? But when I have to make which account and why?

[@TheFinanceStoryteller]

Please study the concept of double entry accounting before asking a question like that: kzbin.info/www/bejne/e5rFmpWMe6qerM0

[@KrishanSingh-gz9op]

Does bad debt expense account & allowances for bad debt account have to be equal ? What if allowances account is bigger than the bad debt expense account? Does it mean that we have overestimated the bad debt expense?

[@TheFinanceStoryteller]

See the answer to your question about the example you pulled from investopedia's bad debt expense page.

[@KrishanSingh-gz9op]

As we transfered $10 from accounts receivables to bad debt expense , it (receivables) went down from $40 to $30. Will bad debt expense also decrease if we transfer that $10 from debit account of "bad debt expense" to the credit account of "allowances for doubtful debt"?

[@TheFinanceStoryteller]

In the video, I am discussing different methods to deal with similar situations. If $10 is uncollectible, you will have to book a debit in the income statement (P&L) and a credit to an asset account (either A/R or allowance for doubtful debt). Every journal entry needs debits and credits to balance.

[@larsvanhout4080]

I know a Dutch accent when I hear one lol. Thanks for the review

[@TheFinanceStoryteller]

Jazeker! 😎 Graag gedaan.

[@KrishanSingh-gz9op]

I know that accounts receivables balance can be cleared if we receive payment from customers or if the customer goes bankrupt (write off receivables). So how can we clear balances in bad debt expense account & allowances for bad debt account?

[@TheFinanceStoryteller]

Bad debt expense is an income statement account, which like any other income statement account gets cleared out during the closing entries at the end of the year. In other words, it affects net income, which will be added/subtracted to equity on the balance sheet at the end of the accounting year. The amounts in allowances for bad debt (which is a contra asset account), get cleared if a write-off is done after booking the allowance, or if good news arrives regarding collectability and an amount can be released.

[@KrishanSingh-gz9op]

Is "allowances for bad debt" also a temporary account? Will it be reset back to zero at the end of the accounting or financial year? If yes, then where does the ending balance goes?

[@TheFinanceStoryteller]

No, it is a permanent account that gets carried over to the next accounting period.

[@KrishanSingh-gz9op]

On which side (asset or liability) of the balance sheet "allowance for doubtful debt" goes ? Is it similar to accumulated depreciation account?

[@TheFinanceStoryteller]

Yes, contra asset account just like accumulated depreciation: kzbin.info/www/bejne/n6nOlamFiZyNeqs

[@KrishanSingh-gz9op]

Are "bad debt expense" & " allowances for bad debt" non cash items?

[@TheFinanceStoryteller]

Bad debt expense is an income statement (P&L) account, allowances for bad debt is a balance sheet account. In income statement analysis, bad debt expense, like depreciation, is considered a non-cash expense item.

[@mskhealthandfitness]

Thank you so much, I was searching about what would happen If the allowance for doubtful debt for the year was more than the Account receivables is was fully collected but there is AFDD I thought this would affect the result of Net Income as we are evaluating bad debt Expense for the period whether there is no real bad debt Expense as more than what we thought we would have not collected is collected, for some reasons the reference book I study from did not mention that point :D

[@TheFinanceStoryteller]

Well done for going above and beyond your textbooks in learning to understand this topic!

[@lowerterror7993]

thank you sir.

[@TheFinanceStoryteller]

Most welcome!

[@soniczforever5470]

I paid my bills but they denied it.

[@jack_0803]

thanks a lot

[@TheFinanceStoryteller]

Happy to help!

[@KrishanSingh-gz9op]

Is my following statement right? :- If a company thinks that it may not receive $10 from its accounts receivables, then it books that loss by showing bad debt expense of $10 in the income statement. After booking that loss it's bad debt expense debit balance goes to zero. And it Transfers that $10 to the credit side of "allowances for bad debt".

[@TheFinanceStoryteller]

No, the statement is wrong.