Allowance Method for Accounts Receivable - Accounting

All right, here we go with the heavy stuff when it comes to Chapter 7

We're going to be talking about the allowance method, and that's the method that we use when we're dealing with receivables

So let's talk about this, and we'll get some more stuff as we go in the videos and whatnot

but I really want to make sure you understand this allowance method, because it's actually going to kind of throw a curveball at you

We're going to introduce a new type of account. So what this does is it matches the estimated losses from uncollectible accounts receivables against the sales they help produce

What that means is when you put it on your balance sheet that you have accounts receivables of this amount and you leave it at that

what you're implying is that this is what I'm going to receive. But in reality, you know you're not going to receive that because people don't pay

Sometimes people can't pay or they don't pay. So by just keeping it at that amount, you're not really showing the full story

And you're also saying that this is everything you're going to receive in revenue and you're going to have to pay the full amount on this

Not keeping up with what you actually are losing. for people not paying. So at the end of the accounting period, bad debt expense is estimated

and recorded in an adjusting entry We got to figure out how much we think we not going to get and that amount that we think we not going to get we going to lose from our accounts receivables We going to go ahead and expense that through what called bad debt expense The advantages of using the allowance method for valuing

accounts receivables are, one, it records bad debt expense when the related sales are recorded

So again, it matches the expense with the revenue. So we're following the matching principle

And it also records the accounts receivables on the balance sheet at an estimated amount

of cash to be collected. So again, I'm giving the full picture to my investors. I'm not saying

this is what I'm going to get. I'm really saying this is what I potentially could get

but this is really what I think I'm actually going to get after they don't pay me. A certain percentage doesn't pay me. So there are a few ways that we can find out that bad debt. There's

three main ways that we can calculate bad debt. The first one is going to be a percentage of sales

method. As the name implies, we're going to take a percentage of what we sell for that year. We also have percentage of receivables method, which is the percent of whatever our receivables balance is

And then we also have the aging schedule or aging of receivables. And that makes it a little bit more accurate because we itemize those things a little bit better

But in the next videos, we're going to be talking about each individual one of those and how we do those methods

Appreciate it