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Accounting Allah shmoop bad debt Okay Back to our little

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company pillow talk Well your little company has grown Now

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you have scale girth numbers volume you guessed inmate that

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you sold pillows to a thousand corporations around the world

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over time Now bulk deals hundreds of thousands of pillows

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or a while A few hundred pillows at least per

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corporation that is as part of National Nap Day All

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right most of the corporations pay you under payment terms

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called Net thirty That is you ship them pillows and

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inside of the giant soft boxes is a bill or

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invoice for whatever amount they owe you They then write

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a paper check and snail mail the payment to you

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Or they pay pal you or Apple pay or venmo

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or they wire it to you via the microchip in

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your brain or something like that In theory what matters

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is that they have thirty days net to pay you

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meaning net as of the day that Phil owes arrived

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on their doorstep So you wait You wait And nine

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hundred ninety five of the thousand companies pay you the

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full amount within that thirty day window But there are

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five deadbeats who don't and in fact you have to

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bug hassle bother and arang them for months to get

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paid to More deadbeats pay late but three of them

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Well they just don't They've gone out of business disappeared

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vanished or you know Jimmy Hoffa So you know you

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won't collect and this happens year after year Same pattern

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roughly the same percentage is So how do you account

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for this issue Well basically you keep a placeholder or

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an allocation or an allowance for bad debts because like

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the sun setting tomorrow you simply know that they'll happen

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again regularly and in about the same way that is

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when you recognize a given million bucks of sales L

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you might up front subtract twenty grand from that number

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on ly recognizing a net nine hundred eighty thousand dollars

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that way in a bad year when bad debts CA

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goto three percent and so the normal two percent the

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shock to the system is only ten grand and not

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say thirty grand as it would be if you didn't

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make that adjustment in advance Right So you'll create an

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allowance for doubtful account accounts on your books So let's

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say that one year things air Rosie It's a year

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when everyone's making money is happy and loves your pillows

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and none of your buyers go out of business If

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you should be so lucky as to collect everything in

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a given year well then you Khun simply take money

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out of the allowance for bad debts or doubtful accounts

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and simply add that dodo revenues bye proactively making estimates

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that follow well established patterns You remove a lot of

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the volatility from your books and you worshipped gap Its

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core precept which is to be conservative when you can

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be in This would be being conservative Okay so how

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does an allowance for bad debt work mechanically or logistically

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Accounting for this process involves a bit of light gymnastics

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When you first sold the pillows net thirty at the

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moment the sales contract was signed and the pillows not

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yet paid for the sale was booked as a receivable

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by you At that same time you had an off

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setting record for product you owed the people who just

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bought those pillows But in this case a receivable isn't

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fully receivable in that there is better than one in

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a million odds that this sale ends up having gone

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to a deadbeat So you have to allow for that

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potential event Big note here If the sale was for

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us a thirty thousand dollarsworth pillows Well you'd shown account

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receivable for thirty grand but then you'd get rid of

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that thirty thousand dollars worth of receivables the moment the

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sale was he'd for This is how a credit sale

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works Because you've been in the business of soft selling

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pillows for a long time Now you simply know that

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on average two percent of your sales don't get paid

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for So in order to reflect that grim reality and

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that there are oh so many deadbeats on earth Well

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you take two percent from the thirty grand receivable there

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and add a negative offset to that thirty thousand bucks

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Right You've got two percent of thirty grand six hundred

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dollars So you'd put six hundred dollars of that two

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percent of the thirty grand into your balance sheet entry

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for allowance for doubtful accounts What if you didn't just

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know that On average you lose two percent Two deadbeat

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Well then you just look to an industry average Most

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industries have publications and openly discussed deadbeats and you would

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just adopt that industry Standard number is your delimit er

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and the pillow industry is no exception on your balance

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sheet Well you'd have entry items that sort of looked

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like this So yeah he always have to watch out

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for the deadbeats and well you should probably watch out

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for dead heads while you're added Well they tend not 00:04:31.463 --> [endTime] to pay either

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