 Hello and welcome to the session. This is Professor Farhad and which we would look at the allowance for doubtful accounts as well as bed debt expense. These topics are covered on the CPA exam far section as well as intermediate accounting course. What I offer you, what the difference between what I offer you and a CPA prep course is I explain the material from scratch. I don't assume any base level of knowledge. So that's why if you want to learn more about this topic, sign up for my website farhatlactures.com where you would learn more about doubt allowance as well as bed debt expense, especially in my intermediate accounting course. As always, I'm going to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lectures, please like them, share them. If they benefit you, it means they might benefit other people, connect with me on Instagram. As I just stated on my website farhatlactures.com, you will have detailed explanation about topics such as allowance, bed debt expense, as well as any and every accounting topic that you can think of. One subscription gives you access to all the material. So the best way to illustrate the concept of allowance and bed debt expense is to actually work examples to show you how this all fits together. Because what you need to know is you need to understand what you don't know. Before you take the CPA exam, it's important to know what you don't know. And how do you know you don't know something is when you cannot answer the questions properly. So let's see how much you know from answering these questions. On December 1st, year five, the Thomas Corp has a credit balance of 700 in the allowance for the outfall account. Now, if they don't say credit balance, if they only say they had a balance of 700 in the allowance for the outfall account, you can assume it's a credit balance. Why? Here we go. Allowance for the outfall account, I call it ADA, allowance for the outfall account is a contra asset, is a contra asset, specifically contra receivable. To be more specific, the asset is receivable. If it's a contra asset, it will have a normal balance of a credit. So it's very important to know this, because sometimes they don't tell you it's a credit balance. They tell you just the balance is 700. So they already have, they're already telling us we have an existing credit balance of 700. Prior to the consideration of the following aging schedule that was prepared at year end. So that's all that we have. We have a balance of 700 dollar credit balance, and they're giving us an aging schedule of the receivable. What amount should Thomas report as an ending in the allowance account? So what they're asking is for this number, they're asking for what should be the ending balance? What should be the ending balance? Well, can we find out what the ending balance is? Well, before we find the ending balance, do you understand what does it mean? What does it mean to have a credit balance? Because that's important. You want to understand what does it mean to have a credit balance? What does it mean? It means in the prior period, prior period, you overestimated your allowance. That's what it means. So the first thing you want to know is the credit balance means it's coming from the prior period. You overestimated. Now what does it mean overestimated? Well, I'll explain this in a moment once we have the numbers in, but this is what it means. So let's find out what should be the balance. Well, so what's that number here? So that's what we're looking for. What's that number? Well, what we do is this. Since we are giving a schedule of aging receivable, we're going to take each group 50,000 times 3%. We're going to take 10,000 times 6%. So and we're going to take, and for the amount over 5,000, they already give us the number is 2,500. So what is 50,000 times 3%, that's equal to 1,500. What is 10,000 times 6%, that's equal to 600, and 2,500 is giving. We add them up. 2,500 plus 1,500, that's 4,000 plus 600, that's 4,600. Voila. This is the target balance. This is what they're asking about. This is the allowance for the ending allowance. So the question is, what is the ending balance and the allowance? The ending balance is 4,600. That's the question. That's the question. So the answer is B. I'm sorry. The answer is very important. A, sorry. OK, I told you. I made a mistake when I said B because it has to be a credit balance. The allowance has a credit balance of 4,600. How much should Thomas Corp record as bad debt expense? So the question is, what should be bad debt expense? Well, let's see. I just told you that we already have, or what's giving to us is, we have a credit balance of 700. And I just told you, this 700 means from the prior year you overestimated. You overestimated your balance by 700. That's why you still have a credit balance. It means you booked that expense and allowance more than what happened, which is not bad, not bad. But now the question is, how much do we report for this year? Well, if my target is 4,600, I need to have 4,600. And I already have 700. All what I need to do is book the difference. And the difference between those is 3,900. Therefore, the entry is bad debt expense, 3,900. Allowance for doubtful account credit, 3,900. And by having here 3,900, 700 plus 3,900 is a credit balance of 4,600. And this should be my credit balance. So hopefully you are able to follow this. Otherwise, if you're not sure how I did this, because I try to explain as much as possible, but if you go to my farhatlectures.com, you will find detailed explanation about this receivable allowance and bad debt expense. Let's change the scenario here. Assume the allowance has a previous balance prior to the adjustment of 500 So it's very important that you read those very carefully. It's a debit balance rather than 700 credit. So on the prior example, this is what we said. In the prior example, we said we have a 700 credit. Now they're saying, let's assume rather than a credit, you have a debit of 500 from the prior period. What would happen if you have a debit of 500? First of all, what does a debit mean? Debit means from the prior year, you underestimated. And when you underestimate your allowance for doubtful account, you'll end up with a debit balance. So maybe you estimated 10,000, you end up losing 10,500. Losing means you had that expense of 10,500, but you estimated 10,000. Therefore you end up with a debit balance. Now if you end up with a debit balance, the first question is this. How much should Thomas record and the allowance for doubtful account at year end? Well, the target would still be 4,600. So the target should be in the allowance based on the information giving 4,600. This should be the allowance balance. The second question reads, how much should Thomas record for a bad debt expense? Basically the same question as in the prior session, except here, we are starting with a debit balance. We underestimate. So since we underestimated the prior year, here's what's gonna happen. We need to book enough credit to eliminate the debit and keep 4,600. Well, how much do we need? Well, I need to have 4,600 plus 500. So I need to book 5,100. Therefore I will debit bad debt expense. That's my debit and it's gonna have to be 5,100. And I credit my allowance for doubtful account 5,100. When I credit my allowance for doubtful account, 5,100, it's gonna eliminate my debit. And it's gonna give me a balance of 4,600. And that's exactly what I'm looking for, having a balance of 4,600 ending allowance balance. Now, here's a trick that you need to remember. After you compute your balance, your target balance, here's what you do. If you have a credit balance, if you have a credit balance, prior credit balance like this one, you will take the target balance, the ending balance. I call the ending balance the target. You take the target minus the credit. So the target is 4,600 minus the credit of 700 will give you your entry of 3,900. Now, in this example, you had a debit balance. What you do if you have a debit balance, you take your target plus your debit balance to find your entry. Your target here is 4,600. Your debit balance is 500, all in all, 5,100. And that's your entry. That's your entry. Again, if you need more explanation, please go to my intermediate accounting foreheadlectures.com. Let's take a look at this question. When a company uses the allowance method to account for bad debt, what effect does a collection of a previously written off account has on bad debt expense and allowance for a doubtful account? This question is loaded. In other words, if you can answer this question, in order to answer this question, you have to have a good understanding of how allowance work. Let me walk you through an allowance complete example to answer this question. So it's better to understand that. I can give you the answer, but I should explain to you how we get to the answer. So here's what happened. At the end of every accounting period, let's assume it's December 31st, year what we do is we estimate bad debt. So what we do is we debit bad debt expense. And I'm going to be using some numbers, 10,000. And I'm going to credit allowance for doubtful account, 10,000. So for this particular company, at the end of the year, I estimated, I think we're going to lose 10,000 worth of, we're going to experience 10,000 of bad debt expense in the coming period. That's fine. This is what I booked. I estimated this at year end. Then what's going to happen? We're going to move on and life will go on. And we're going to find out which account, which customers, or which accounts specifically, are not paying. And as a result, we might remove them. So let's assume I find out that Farhat accounting lectures is not paying Durbell and they owe us $2,000. And we contacted Farhat accounting lectures. We send them emails. We send them letters. Our lawyer called them. They're not paying. They're simply, you know, they're going bankrupt. So what we do, once we give up on a client, and let's assume on April 1st, kind of we made a decision, Farhat accounting lectures is a deadbeat customer. Let's write off their account. So what we do when we write off an account under the allowance method, we debit allowance for doubtful account, 2,000. So simply put what I'm going to do. I'm going to keep allowance for doubtful account balance here. Remember, we had 10,000. Now we debited 2,000. We still have 8,000. So we debit allowance for doubtful account, 2,000. And we're going to write off the deadbeat Farhat accounting lecture account, account receivable, 2,000. At this point, we wrote off the account receivable for Farhat accounting lectures. Guess what? A month later, May 1st, Farhat accounting lectures. The owner won the lottery and this guy, which is me, decided to pay back my 2,000. So I decided to go back and pay the 2,000 because I really owe this company 2,000 dollar. So what would the company do? What would the company do? Here's what the company would do. First, the company would reverse what they did. So they will debit my account receivable 2,000 and they will credit ADA 2,000. Then they will debit cash 2,000. Then they will credit account receivable, FAL 2,000. So the question here is, the question, let's go back to the question, when the company uses the allowance, what effect does a collection of a previously written off account? So the previously written off account is this account here. This is where we wrote off the account. So what effect does a previously written off account has on bad debt expense? And the answer is, nada. There is no effect on bad debt expense. Notice we did not use, we did not use bad debt expense. We did not use bad debt expense in this example in any way, shape or form. So notice bad debt expense was not mentioned here. Therefore, the answer is, bad debt expense increase that's out, bad debt expense decrease that's out. No effect, no effect. So we have A and D. What about the allowance? Well, guess what? After they paid us the money, we put back the money in the allowance. We increased the allowance by 2,000. Now we're back to 10,000. So the allowance will increase. The allowance for doubtful account will increase. So the allowance is, notice the allowance went up. No effect on bad debt expense. The allowance went up. The allowance went up. So I'm just going to take this example a step further. I want to explain to you what I meant by underestimate and overestimate. Here's what I'm going to show you. Let's assume, let's rewind and go back and assume FARHAT never paid the 2,000. They never won the lottery. Let's assume this is what end up happening, the whole year. The whole year is FARHAT bailed out on us and we still have 8,000 credit balance. If that's what happened, we have a credit balance. It means we overestimated the balance. It means we overreported the balance. We overestimated the balance. That's what it means. But let's assume another client, another client, they owe us $15,000 and it's ABC client. So on May 15th, we figured out that ABC client is really, you know, it's not going to pay us. So we debit allowance for doubtful account, $15,000. It's a big account and we credit account receivable ABC company, $15,000. Now what we do is we debit allowance $15,000. Notice now, now we have a balance, let me write it here. Now we have a balance of 7,000 debit. If we end up with a debit balance, it means we underestimated. And this is why I was saying it's very important to know what does that mean if you end up with a debit balance and the allowance or a credit balance. Because in the following year, you will make up the difference. You will make up the difference. As always, if you like this recording, please like it. But if you want to learn more about this topic that I don't believe your CPA prep course does a good job explaining. It's not they don't do. It's they assume you know the basics. I don't assume anything. If you go to my intermediate accounting or to my supplemental CPA material, you will have a detailed explanation about what I just did. Check out forhatlectures.com if you're interested in improving your grade and adding 10 to 15 points to your CPA exam. Good luck, study hard and stay safe.