Allowances for Doubtful Accounts - Accounting

All right, before we get into the methods and how we do the allowance method, I want to introduce you to this new account that we're going to talk about, which is called the allowance for doubtful account

And it's a new type of account. You know, we've talked about our assets, our liabilities, our equity, our revenues, and our expenses

But this is a new type of account. And so it's really important that you understand how this works because it'll make a little bit more sense as we go through these problems

So the allowance for doubtful account, it's what's called a contra account

okay and a contra account is really well let's let's go through this let's say hypothetically we have

a r and a r is represented by our folder and in that we're going to add you know sometimes people can

buy something for a thousand we're going to add that and then 2,000 and then 500 and then 4,000 whatever

they're going to add all these to our accounts receivables and when they do that some of them

are going to actually start paying some of these off as well so they may have you know 500 they're

going to pay off of the thousand and they're going to have the two thousand to pay off in this entirety they're going to have all this and then once i add all this up this is going to give me

5 000 as my ar balance okay so this is pretty much what we know as our ar t table right now i still owed I still owed Now if I go to my balance sheet with this information I would put it under assets and you start with cash we know something

And then we would have AR, our accounts receivable. We would put $5,000 there

But that's not exactly right because what that's showing is this is what I'm owed and going to receive

That's not right. I know I'm not going to receive all that because based on historical evidence

I know I'm not going to receive every penny of this. So it's really not right for me to show my investors this is what I think I'm going to get

This is what I have the opportunity to get, but I really know I'm not going to receive

every penny of it. So I've got to figure out a way to give more information to my investors, but still be able

to keep this 5,000. And that's where the allowance for doubtful accounts comes in play

So what is the allowance for the doubtful accounts? It is a type of, like I said, it is a type of contra accounts

When you think of contrary, you think of contrary opposite of, and that's exactly what this is

It is an account that is an asset account, but it works in contradiction to some other parent account

So we know assets on a T-tibble to be plus minus, a contra-asset account is minus, the debit is a minus and the credit is a plus

A contra account also works together with what we call a parent account It is connected to a parent account So when you have AR you also going to have allowance for doubtful account or what do we call ADA

And ADA is going to offset the value of the AR. So the Contra account is a general ledger account

that produces the value of a related or parent account when the two are netted together

And the Contra account works in contrast with the parent account. So let me show you how this works using the example

with the envelope. So now we have our envelope again, $5,000. And that's what we're, if we keep it there

we're saying that this is what I'm owed and what I think I'm going to receive

And we know it's not what we think we're going to receive. So what we need to do is we need to take a bit of that

$5,000, what we think we're not going to receive from that. And we're going to put it into another envelope

And that envelope is in our AR envelope. So it's kind of like an envelope within the envelope

And so let's just say, I'm going to take a bit of this. I'm going to take $200 out of that

And I'm going to put it in the ADA. And what I'm saying is, OK, I have the potential

to get 5 That doesn change but I think I not going to get the So therefore what I really think I going to get in cash is And hopefully you can start to see how that more informative to investors Ideally they going to get but we know that not going to be right They think they really not going to get 200 So really they really truly think they only going to get about 4 And that how you would read into that

So looking at it from, again, even by doing this, my AR balance is still 5,000

If I was looking at this from the balance sheet, it would look like this. Again, I would have my cash, whatever

That's my starting point. Then I'd have accounts receivable of 5,000. This is what I have the potential to get

This is what I'm owed, what I could get in total. But I'm also going to have my allowance for DALFA accounts, and that's going to be a negative number because it offsets

And this is what I think I'm not going to receive. I'm not going to get. And if I take the difference between those two, that's going to give me my net realizable value, the total cash value

If I take the difference of, it's going to give me $4,800. So again, this is what I really think I'm going to get or receive

So, like I said, this is just a more informative way to keep up with stuff. And then that allowance for DALFA accounts, I'm able to expense and take it off of my revenue

I don't have my net income, so I don't have to pay the tax along what I think I'm not going to get. And so that's the premise of allowance for doubtful accounts

As we go through this, and you're going to see some examples and stuff like that in the next videos of, you know, this actually working in process

So hopefully those will make a little more sense to you as well. Appreciate it