5. Net Credit Sales

I wanna talk to you for a second about credit sales. I've told you that under the income statement method, you take credit sales, and you multiply that by some percentage, and that gives you your bad debt expense. But what is this? How do we know this? There are a couple things that may trip you up that you need to look out for. You may see something like this. Sales were, let's say, $10,000, of which 80% were on credit.

Use the income statement method, blah, blah, blah, to find the bad debt expense. Management estimates 1% uncollectible. Now, the trick is you may go $10,000 times 1% equals $1,000. That's my bad debt expense. A plus. Well, that's not right. Here's the problem. Sales were $10,000. 80% were on credit. Where does the other 20% go? So if we have 100% and 80 went to credit, well, the other 20 presumably went to cash.

That's the mix, 80 credit, 20 cash. Now, the thing about cash is you don't have to collect it because you've already collected it, right? So you can't have uncollectible cash because the customers gave you the money and then left the store. You already collected the cash. So on the 20% cash, there is a 0% risk of uncollectibility. On the 80% credit, there's a 1% risk based on the problem.

So if you were to do $10,000 times 1%, you're including in that the 20% cash that you've already gotten, that there is literally a 0% chance that you won't be able to collect on. So when you see a problem that says sales were $10,000, 80% were on credit, first thing you need to find out is, well, what is my credit sales?

Because only my credit sales are at a risk of not being collected. So you say $10,000 sales, 80% were on credit, so $8,000 was on credit, and of that, 1% may be uncollectible. So then $800 becomes your bad debt expense. So that's one to look out for. Look out for when the teacher says sales and doesn't say credit sales. Another one to look out for may be when they say credit sales were $10,000, returns and allowances were $500. We estimate 1% uncollectible. What is bad debt expense? Okay, so now we don't have the same issue that we had above because we've been told credit sales were $10,000, so we don't have to figure out what credit sales are.

Now, why is returns and allowances important? Because we've already given back $500. So we sold $10,000, of which we gave $500 back, so outstanding, we only have $9,500. This is what our customers owe us, not this, because we had to give back $500 for returns and allowances. So really what we're looking for is net credit sales, because we're not really trying to collect this $500 because we gave refunds for that. So what we're trying to collect is this $9,500. So then you say $9,500 times your 1% is $95 bad debt expense. Did I do...

Yeah, I multiplied that by 10%. That should be $80. I multiplied that by 10% instead of 1%. So what we're really looking for is net credit sales, because like we said up here, there's no risk, there's a 0% risk that we're not going to be able to collect cash we've already collected. So that takes us from sales to credit sales.

So we say, "This is all of my sales. This is my credit sales." Then my bad debt expense would be 1% of my credit sales. But then what if we have credit sales of which we had some returns and allowances or some discounts? Same thing. Well, we're not expecting to collect any of that $500 because those were refunds. So we need to take our credit sales, take out any returns, allowances, or discounts, and come up with your net credit sales. Then once you have net credit sales, you multiply that times your percentage uncollectible and end up with $95. And hopefully, you can do math right on the test, unlike me, who can't do math right when they're recording a video.