hi class this video is going to run through a quick summary of how to record in vce unit 4 accounting bad and doubtful debts so if you're using the McMillan textbook like my class is this is all about chapter 14 this video is not going to run through an exhaustive list of everything you need to know but it's going to hone on the important steps that you need to really remember and particularly when recording estimating bad and doubtful debts so what is a bad and depthful debt and why do we need to consider this particularly for the qualitative characteristic of faithful representation given the what we need to understand when we're talking about doubtful debts that there is no certainty that all the amounts owing from our sales so our accounts receivable will be collected because of this we need to have two do have or do two things we need to make a prediction or have an allowance for doubtful debts and we'll go through what that is in a second and we also then need to record bad debts so we need to understand what these two terms mean and know how to record these using our Pro accounting process in year 12 accounting of General journals and general Ledges but what is an allowance for doubtful debts this is the first one that you need to know an allowance down for debts recognizes that some amounts owing by accounts receivable may not ever be collected so a certain percentage of what is owed to us will not be collected an allowance for doubtful debts then is hence a negative asset account and what I mean by that is we're going to recognize that some of our assets accounts receivable will not be collected and hence we should if we think about it reduce how much that asset is how do we do this through allowance for doubtful debts which is a negative asset account so it reduces how much we are are owed importantly this is a prediction because we never 100% know how much will not be collected businesses get really good at predicting but it's still a prediction this is different to a bad debt a bad debt is an expense so if we think about it negative asset account expense created when a customer an accountable is written off as Rec IR recoverable lots of key words there but what is it specifically talking about that's different to allowance for doubtful debts we know the specific customer that can't pay us back so allowance for doubtful debts a prediction that some customers don't can't pay us back bad debt when we recognize that the specific customer C pay us back what's the the difference allowance for doubtful debts is a negative asset and a bad debt is an expense so we understand that they're going to be different things in different reports what is the process firstly we're going to establish an allowance for doubtful debt we're going to establish our prediction and then when we get to finding out which customers can't pay us back we will actually write off the specific customer when they become a bad debt so you might go on and there is must be two steps that I need to remember there are actually three steps and we're going to run through in three different slides each of these three steps and then talk about one final complication and that will give you most of the tools to be a to complete your bad and doubtful debt questions so step one firstly we need to do the prediction we need to establish and report an allowance for doubtful debts create our negative asset account and work at our prediction now an allowance for debt for debt is based on a percentage of net credit sales it's a percentage because it's a prediction and when you see net credit sales this is always what we times our percentage by and net credit sales is sales or credit sales minus sales returns because sales returns are ones that have come back to us these will never be needed to pay they never need to pay us back so they're not going to be ones that we can't collect the money from because they don't owe us any money so let's look at an example we have credit sales of $100,000 sales returns at $4,000 and 5% of credit sales normally go bad we have enough information here to work out our allowance for doubtful debts in this case it is 4800 of allowance for de bad debts or allowance for doubtful debts how have I worked that out 96,000 * 5% or 0.05 96,000 because net credit sales is one credit sales minus sales returns so 100,000 minus 4,000 how do I record this in my general journal I have a template my template is I'm going to do a debit and credit and my debit is going to be bad debt expense and my credit is going to be allowance for doubtful debts I have a narration here which you can REM memorize because this will be our template I'm doing an adjusting entry to establish an allowance for doubtful debts at x% of credit sales why are these debits and credits if we think this through I'm recording that my prediction that my assets are not worth as much as I thought they were cuz some won't pay me back what is my asset accounts receivable so how do I reduce an asset I do a credit so this is my allowance for doubtful debts I'm also going to record an expense because this is an essentially a cost of doing business and an expense here is bad debt expense and expenses going up as a debit so how would I record this in my actual example here by just using that template and plugging in the 4,800 that I've calculated so I have an allowance for doubtful debts of 4,800 and a bad debt expense of 4,800 my narration slightly changes because I know the percentage that I'm putting in that is your first step we have now got an expense that would be reported in my income statement as an other expense and I also have something that's reduced reduced my assets an allowance for doubtful debts is reported in the balance sheet as a negative asset what do I mean by this I'm still going to say that my current assets have included An accounts receivable and you can see here it's $80,000 now you might be going how is it $80,000 when I had credit sales of 100 remember some are going to be paying us back as we go through so this number is is going to be different but I'm going to record that I have an allowance for doubtful debts of 4,800 which means 4,800 are likely not going to pay me back this means my current assets of accounts receivable at the balance date in this case reduced by 4,800 to 75,200 step two is when we write off a bad debt even though we have established lished an announce for doubtful debt we've established our prediction and recorded an expense the next step is to identify and record specific customers when they can't pay us back so this is when I'm talking about writing off an account as a bad debt so let's look at an example I've done my step one but throughout the next period I've discovered that Sam Smith has been declared bankrupt and he not able to pay any of the money owing this customer had a debt consisting of a credit sale of 3,300 including GST so what does that mean this customer has been recorded as an account receivable of $3,300 however when this has occurred we now need to reduce how much this customer owes us because they can never pay us back it is no longer an asset so how do I reduce how much much a customer owes us I am going to do a credit in the specific accounts receivable with the name there if we in the question it doesn't require you to talk about the name you wouldn't have to it would either be accounts receivable name or accounts receivable in blank and question should make it clear what we are also doing is you might remember we have also already reduced our assets through allowance for doubtful debt we've Al so we're now going to remove that prediction of allowance for doubtful debts by how do we remove a part of it by turning the credit into a debit because that prediction has come true so we're crystallizing that there is also some GST here which we would not expect us to receive we're not going to receive that GST anymore if we're not going to receive the GST we don't are not expected to pay it to the the government so the liability that we're expected to get the GST we're going to receive the liability being a credit because liability is going up as a credit is not needed so we're going to reduce our GST so in this example I would have an allowance for doubtful debts of 3,000 GST clearing of 300 and Sam Smith cannot pay us back the full amount that he owes us of $3,300 Cs receivable Smith Goes Down by 3,300 being a credit because assets go down as a credit GST was 300 which we will not need to pay to the government so our liability goes down debit and allowance for doubtful debts we you had a prediction we've now removed part of that prediction so our credit becomes a debit why is this allowance for doubtful debts included here why are we not recording this as an expense it is debited against the balance of allowance for doubtful debts as the business allowed has allowed for some bad debts to occur we've already made this prediction and the prediction in some part has occurred so this is why we don't create another bad debt because we' be double counting we've already if you remember recorded $4,800 of bad debt expenses so we would be double counting if we recorded this as a bad debt expense in here we are just crystallizing that one customer can't pay us back and this might make sense and we go I've done my two steps finished the third step is we need to adjust the allowance for doubtful debts for next periods because accounting doesn't happen in just one prediction we keep moving on so we estimate we need to estimate the allowance for doubtful debts that should be for the next period so to do this this we need to do a number of things we need to take into account the estimate of bad debts for the next period how much will we not collect in the next period and most importantly we need to look at the difference between the last period prediction and the actual bad debt so let's have a look at an example to continue this on in the next period credit sales were $110,000 and there is an assumption that there is no sales returns here so we've had a good year period in terms of that we fix the quality issue an allowance for Deb should be 4% of credit sales so you remember it's gone down a little bit now the estimate for allowance for doubtful debts now is $4,400 4% of $110,000 equals 4,400 so logically we are then going to pick up this allow and recorded in our general journal following the first template from step one so we have done a credit for a layouts for doubtful debts recorded our prediction and recorded our expense of bad debt expenses being our debit we've done also our narration adjusting entry for the establishment of allowance for doubtful debts of 4% of credit sales but hopefully what's screaming out to you now is my debit and credit are 26 $100 why the hell is it that when I've just worked out my prediction is 4,400 the answer is in the second part of this process we need to look at the difference between last period's prediction and what actually happened if we think about what actually happened last period and this is what my ledger would look like for allowance for doubtful debts I predicted there would be $4,800 of bad debts the was only if we assume Sam Smith was the only one only $3,000 of bad debts so what have we actually done we've overestimated how many customers wouldn't pay us back we overestimated by $1800 so we because we were penalized for a previous period we should be rewarded for this period so the difference of last period is an overestimate of $1,800 4,800 - 3,000 therefore the new allowance is 2600 because we reward ourself for making it being being punished for this one if we then think at this through we recorded 4,800 in the last period we're recording 2600 in this period so that is $7,400 of overall bad debts that we're predicting that equals the 3,000 from last period that actually happened we don't need to worry about about the prediction now and the new 4,400 that we predict for this period And this is where it then balances out that is the three steps there is however just one last complication that we really should be aware of and this is called partial payment most often and often in the real world this is more likely to happen a bankrupt customer may make a partial payment on their account they've gone bankrupt but they do have a little bit of money and they're going to and by law they must try and meet all their payments as best as possible so let's keep the same examples if Sam Smith owed $4,400 but could pay 25 cents in the dollar therefore if the business would actually receive $1,100 so when this was then recorded the account receivable of $4,400 now would now no longer exist because I can't pay it back it's no longer asset but we would recognize that we did get partial payment so our cash another asset has gone up by 1,00 and then we continue on recording our allowance for doubtful debts and GST clearing here to recognize the crystallization of our prediction and guys that is how we record bad and doubtful debts as outlined in chapter 14 three important steps we need to understand how these work we need to understand the definitions of allowance for doubtful debt and bad debts understand that partial payment is a common exam question and by doing this and practicing lots of questions we will become a master of honestly one of the more complicated parts of unit 4 accounting keep practicing your accounting