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Bad Debt Reserve (Allowance) | Example | Journal Entries - YouTube
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we're going to learn a concept that is
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the bad net reserves or the allowance for
the bad debt expenses let's try and
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understand in the detail format as you
can see over to hear detail of the
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shutterstock.inc consolidated financial
statement and we have the detail of the
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cash flow statement from the operating
activities there we have the data of the
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bad debt reserve as 1292, 2992 and 3175
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or 6 it is for 2017 2016 and 2015
respectively this was just to show how
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or where exactly bad debt reserve is
been recorded it is also
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the part of the profit and loss
account where it is deducted from the
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bad debt and including in the data is also
it is how it takes into it it is taken
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into account now let's understand what
exactly bad debt reserve is all about
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see bad debt reserve is an account which
offsets which offsets or reduces the
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account receivable that is your details
in the books of accounts so the thumb
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rule of the business in generating
profit so keeping nonprofit organization
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a side which works for the betterment of
the society all other organization works
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towards the earning or for profit you
can say that they earn for profit by
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means of increasing the revenue so we
all know that revenues earned by the
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organization is not settled by the cash
at the time of delivery of goods or
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computational service so there is a time
lag in between which we refer to as
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credit period example like you know the
great in company let's say is involved
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in the business of manufacturing having
many heavy machinery which generally
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costs machinery that costs closely
to more than
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100000 per piece and in this case
the payment terms defined as for the
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company policy was something like this
you know the advance was 10% on
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the acceptance of the order second the
release of the 30% of the
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payment on completion and 50%
of the work order after the
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certification of the completion there
was also a release of a 30%
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of the payment on delivery of the
machinery to the at the customers
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warehouse another clause that release of
the full and final payment within
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closely to 30 days after the delivery so
you must have noticed you know the
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payment terms in the above case a bit
complex now let's take another example
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letting us take an example of small n
company which is involved in the
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business of supplying leather
necessaries the great policy of the
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company is that you know the all the
payment is due within let's say
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45 days of the delivery of the goods of
the customers from as opposed to the
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great in company that were discussed
here small company has very simple
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payment terms no matter how simple or
complex they create policy or payment
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terms a company has they are bound to
some credit risk that is involved
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greater is nothing but the fact that the
customer might not end up paying the
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amount when it is due so there are two
thoughts about the fact that this would
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lead to loss to the company so to
account for the loss the company
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maintains a provision in its books of
accounts which are known as the bad debt
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reserves account right so why is this
bad debt reserve account is required see
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accounting has its own rules and
principles right which needs to be other
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- while maintaining and updating the
books of accounts the basic governing
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accounting principle that is the
conservatism principle of accounting
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which indicates that you know any losses
that should be accounted for it the
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earliest while the profit should be
accounted for only after these
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sufficient proof
or of that particular thing is available
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or is available that the profit will be
accrued in the near future so since
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there is always a possibility of debt
debt turning into bad and the customers
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not paying the complete amount we tend
to maintain or reserve in the books of
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accounts for the future event which we
called as he bad debt reserve now you
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must have got a clearer idea regarding
bad debt reserve now let's take an
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example so as to understand this in a
more detailed and crystal-clear format
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so to understand how bad debt reserve
works let's understand let's first see
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the basic entry which we pass for the
accounting or credit sale transaction
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in the books of accounts let's say
there's a company called kg Inc which
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has received in order for let's say for
500 leather wallets leather
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wallets is what they have got the order
for now the selling price for the
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product is let's say 10$
each and it has successfully delivered
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this goods at the customer's warehouse
as for the pre-approval terms of trade
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so the risk of the inventory has passed
on to the customer when the customers
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accepted the delivery of the goods and
at this point of time will pass in
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journal entry something like this the
account receivable account that will be
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debited which will be closely to 5000 to the sales account that will
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be 5000 so as we can see that
you know the account receivable will
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always show a debit balance in the books
of whereas you know the sales being the
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revenue will be transferred to the
profit and loss account right so in that
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scenario what we can do that you know
now as for the purpose of the bad debt reserve
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is to offset the account receivables
it hat it has a credit balance right and
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the entry for the same will go something
like this like you know the bad debt
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account or the bad debt expense
account will be debited
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that will be 50 and too bad debt reserve
which will have a credit entry to the
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extent of 50 so the bad debt reserve
account will reduce the account
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receivable over here by $50 in the net
account receivable to be presented in
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the books of accounts will be at 4950
5000 less 50
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right in the balance sheet of the
companies in the in the company now
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let's understand the bad debt reserve
accounting see as you must have noticed
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you know there are two different
accounts that have been used for giving
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for to give the debit effect for the
above bad debt reserve journal entry this
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because you know there are there are two
ways to account for bad debt expense one
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is the direct bad debt written off method
now this particular method is used when
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the organisation can pinpoint invoice
for which the payment is not going to be
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received so this method invokes or you
can say that this method involves
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writing of the revenues itself and it's
possible when there is one-to-one
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correlation this is very important point
for this particular method a one-to-one
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correlation between them
between the sales and the debt turning
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bad so this is an aggressive method
quite aggressive one and and in the case
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the entire invoices reverse which also
leads to the reversal of the taxes and
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the other statutory dues booked along
the invoice a second which is known as
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the provision method now this is the
less aggressive method to account for
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the bad debt reserve in this case you know a provision is created for the bad debt
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expenses which can be written off in the
next accounting period and again a fresh
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provision is created so most
organizations prefer to go ahead with
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the with this particular method and this
method goes hand-in-hand with the
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matching concept you can say matching
concept and the accrual accounting of
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system okay matching concept is
basically the revenue that has been
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booked in the
given period of time and should be
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matched with the expenses incurred
towards earning that revenue which
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basically means that the expenses should
also be recognized in the same period in
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which the revenue has been recognized so
by using the provision method you can
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recognize the bad debt allowance in
the period in which the revenue is
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booked now
the above advantage of the provision
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method is the disadvantage of the direct
bad debt written-off method so there
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will be always be a time lag between or
time lag when the revenue is booked and
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the company is sure that the amount will
not be receivable so this does not go
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well with the matching concept with the
accounting and so it's therefore not
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accepted by the accounting standard as
well so or there are a couple of methods
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that you can know they're techniques to
estimate the bad debt allowances the first
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method is by you know you can go for the
historical method the second method that
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people takes into account is the Pareto
analysis a very fantastic way of
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analyzing things in any business okay so
this were the two methods that can be
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used in the course and there are a
couple of things that you know bad debt reserve
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are used to basically manipulate
the books of accounts see bad debt reserve
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are like you know here's a good
technique which can be used to decrease
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the net taxable profit of the company
which will help actually to reduce the
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tax expense and therefore you know there
is a strict rules which will prevent the
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companies to take benefit of the
bad debt reserve for tax saving purpose
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this is it for the bad debt reserve if you
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