What happens when a customer doesn’t pay
its debts it owes to a business? I’m Thomas Harwood and Welcome to The Accounting
Student, where we create free and short videos so that you can learn about accounting. Today’s video is looking at what are bad
debts. In modern times, many goods and services are
sold to customers on a credit basis. This means that the goods or services are
provided to the customer now and then paid by the customer at a future date. Usually, a customer will be given 90 days
to pay for the debt. A business that operates in this way, i.e.
by selling on credit, runs the risk that some of the debtors will either not pay at all
or only pay partially. If a business decides that there is a high
possibility that a particular debtor will not pay their debts, then the debt becomes
a bad debt. Here are some of the main reasons why a bad
debt may arise: A customer may go bankrupt
The business maybe a victim of fraud There could be a dispute on whether the goods
were delivered There maybe a dispute about the standard of
service And the debt might be too small to be worth
pursuing in law If a business identifies that there is a bad
debt then this will be recorded in the accounts as an expense on the balance sheet and will
also reduce the net income by the same amount. Lets have a look at a quick example of a bad
debt. Jon is an online reseller. He recently sold
some books to a customer on credit and it was agreed that the customer will pay Jon
within 30 days. It is now 40 days after the credit sale of
the books. Jon has been in contact with the customer several times urging for the payment. What should Jon do with this in the accounts? If the debt is small then it may not be worth
pursuing the recovery of the debt in court as the fees may surpass what may potentially
be received. Additionally, as the customer has exceeded
the 30 day agreed credit terms then Jon should consider the customer as a bad debt. So that was the explanation of what are bad
debts. If you enjoyed it, press the like button. If you have a question you want answered leave
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