Allowance For Bad Debt
Also, called the "allowance for doubtful accounts", which is a bit more of a positive take on a gloomy topic. Banks record their estimates on loans they predict will go into default and not be repaid using the allowance for bad debt account.
Accountants must have balanced balance sheets (or they wouldn't be called balance sheets). The allowance for bad debt is a category accountants use to balance their sheets. Say a bank loans out $10,000 and estimates that 5% of the loans will go into default. The bank's accountants will enter $500 under the category of "bad debt expense" as a debit in accounts receivables, and $500 credit as an allowance for bad debt. So, basically, the allowance for bad debt is a way to offset the bad debt estimate. It's like a reserve in case a customer doesn't pay up.
Here's how it works if a customer actually doesn't pay up: Say in our example, a customer defaults on $100. This will be recorded as a $100 credit in accounts receivable to lower this amount, and as a $100 debit in the allowance for bad debt account. Seems a little counterintuitive, but it works.
Related or Semi-related Video
Finance: What are Collection Agencies?12 Views
Finance, a la shmoop. What are collection agencies?
All right so sometimes when a man and a woman have trouble getting pregnant well [A couple kissing]
the guy has to go to one of these places, oh wait that's a different kind of [Stop sign appears]
collection agency, sorry just kidding. All right well a collection agency in the finance world
is seeking a different form of currency that is literal currency, greenbacks [Lots of money being counted]
cashola, whose money are they after exactly? Deadbeats, anyone who made a
promise to remit payments to pay back a mortgage, to pay off a credit card, to pay [Wads of money]
out for a jewelry thing at the mall, to pay for a tattoo down there as well. [Someone getting a tattoo]
You name it and then they defaulted on that promise to pay back the vendor, yeah
because when you sign your name on the dotted line and agree to pay back a
lender for their generous loan or extension of credit or agree to buy [Someone signing a contract]
something and pay someone 30 days later for it, paying them back is really not a
suggestion... Once you fall behind enough in your [Woman who is owed money does not look happy]
payments and you're a real deadbeat well they call a collection agency who then
tracks you down delivers nasty threatening letters to your mailbox and [Letter being posted]
if it's a New Jersey collection agency well they usually send someone to break
your kneecaps with a billy club, yeah they still do that... If the message still [Guy opens his door to find a man in a suit with a bat]
isn't getting through to you well the next step is for the agency to set the [Truck wheels]
wheels in motion that will result in the repossession of your home, your car, your [Repossessed notice being nailed to a house]
treasured signed set of Big Bang Theory trading cards you swore would be buried [Gravestone with the trading cards sticking out of the ground]
with you. So yeah if you choose not to make good on your obligations well you
shouldn't expect the people you owe to forget about you, or to go easy on you
like why should they would you do that for them, because they will stick a
collection agency on you, which is not a good feeling when you're up to your [Guy stood in a pile of bills]
knees in debt, or if you live in New Jersey up to your thighs... [Guy who has had his legs beat off in a pile of bills]
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