 In this presentation, we will take a look at a comparison between the allowance method and the direct write-off method. When considering both the allowance method and direct write-off method, we are considering the accounts receivable account. Remember that the accounts receivable account represents money that is owed to the company, typically from sales made in the past on account, haven't yet received the funds for sales made in the past and therefore the company is owed money. We see this amount on the trial balance, in this case $1,191, we then want to know information about that, including who owes us that money. We can't find that typically in the GL as we have a GL for every account, the GL only given us the information by date. Typically we want to see that information also broken out in the subsidiary ledger saying who owes us this money. A problem that we have is that the accounts receivable represents funds we have not yet received and may not receive if there is some problem with some customers we might not get the funds. The question then is should we be writing off this amount at the point in time that we believe we're not going to be able to receive it, should we be estimating how much we think is not going to be collectible or waiting until the end of the time period until we determine that something will be uncollectible. The generally accepted accounting principle, the principle that we should typically be using if under GAAP generally accepted accounting principles would be an allowance method meaning that we would be writing off or matching up with the accounts receivable an allowance account that would be an estimate showing us what we think or believe based on past experience will be uncollectible on the balance sheet and that would write down the accounts receivable and not overstate the accounts receivable and we would also be writing off the bad debt expense then at the point in time to match it up with the revenue at the same point in time. The other method is going to be the direct write off method which typically is not a generally accepted accounting principles method unless the amount of the uncollectible receivables is substantially small and therefore not material to decision making. Otherwise if we're a smaller company and we're not publicly traded we may not have to be regulated under the same type of rules and may not be restricted to the method we use and therefore we need to make a decision. Do we want to use one method or the other? The direct write off method has the benefit of typically being easier to use because we can just wait. There's no estimate happening. We can wait until we believe something is not going to be collectible and then write it off. Note that that does distort the income statement in some ways because we're writing it off at a later time period and therefore not matching it up with the revenue earned in that time period. It also gives us an ability to distort that income in some ways because we can make a decision at the end of the time period to write it off or not. Maybe we wait until the next year or not whereas if we use an allowance method an estimating method then we have to make some type of reasonable estimate. Those are going to be the pros and cons between the two methods. We'll go through and look at them both. Here's going to be the direct write off method where we are going to say that this customer is not going to pay us 9,000 that we've determined it at this point in time and therefore we're going to debit bad debt expense and credit the receivable at this point in time. The difference here being the bad debt expense which brings down net income at the time when we determine it's uncollectible. If we post this to the general ledger we're going to say that bad debt is going to go up from zero up to 9,000 by this debit. That 9,000 then represented here on the trial balance. The accounts receivable is going to go down because they don't owe us any more money or we've given up on it. The receivable is going to be credited. Here's the GL account 1,200,000 going down by the 9,200,000 at 2,191. That then being represented on the trial balance as well. We can see then on the trial balance that we have the revenue is now going down by the bad debt. The net income then being decreased at the point of time we determine that the bad debt would be uncollectible. We also want to see the information that would back up the accounts receivable that would be on the accounts receivable subsidiary ledger. Here's the CW company, ONS 9,000. We're writing that off bringing the balance down to zero after that point in time after we write this off. So now it's down to zero that would be owed to a certain. Remember that the subsidiary ledger would include all people that owe us money, all companies and people that owe us money, and if we added them up it would tie out to what is on the trial balance as well as what is on the general ledger. If we contrast that to the allowance method we have the similar journal entry decreasing the receivable here, but the other side not to go into bad debt but instead go into the allowance account. So now we have the same accounts receivable result. It's starting at 1,200,000 going down by 9,000 to 1,191, however now we're using this allowance account which we weren't using before, we just had it as a demonstration and we had already estimated that there's 40,000 that was made in the prior period, the prior year or the prior month that we wrote off in the prior period to match it up to the revenue in that period and we created this allowance account. And now we're just going to write down that allowance account. No effect down here to bad debt at this point in time. No effect to net income at this point in time. We at the end of the period will make an estimate based on the revenue and or the accounts receivable to determine how much of this revenue we think is going to be uncollectable and therefore be matching up with the matching principle. So in this case when we write it off there's no effect on the net income accounts it's just affecting this allowance account which we had set up prior and we still have the decrease from the 9,000 down by the 9,200 in the accounts receivable. So we have the same activity in the general ledger in terms of accounts receivable back to that 1,191, 1,191. If we take a look at a side-by-side comparison here's the bad debt, the direct write-off and here's the allowance method. So here we're not using the allowance account under the direct write-off method it's just there to show what account would be used under the allowance method it's not being here used under this side the direct write-off it is being used over here. We can see that we have the 1,191, nothing in the allowance it's not it's not a relevant account under the direct write-off method. Over here we still have the 1,191, but we have this 31,000 which was there prior it was created prior to this time period when we wrote off the bad debt related to the prior time period. So this 31 is still left over that we think could be uncollectible or become uncollectible at some point in the future based on an estimate. On the income statement side we decreased net income by that 9,000 so the 378,000 minus this 9,000 is the 369. On the allowance method no write-off to bad debt at this point in time we won't write it off until we make an estimate at the end of the time period based on either revenue or our accounts receivable. Next transaction G company payment 20,000 of 30. This is going to be the direct write-off half of this so we're looking at the direct write-off. We're going to say that we did get cash so we debit the cash it's increasing. Then the accounts receivable is going off the books for the 30,000 the entire amount owed. We're not going to get the added 10,000. The difference then it's going to be the 10,000. We have to put it somewhere this will be the difference between the two methods. Under the direct write-off method we'll write it off to the bad debt expense. Under the allowance method as we will see in the next slide it would be going to the allowance for doubtful accounts. If we record this then cash is going to go up 100,000 plus the 20,000 to 120. We can see the accounts receivable is going to go down. We're at $1,191,000 down by the 30,000 to $1,161,000. This matching up with what's on the trial balance now the $1,161,000 and the $120,000. And then we have the bad debt which is going to go from the 9,000 up by 10,000 to 19,000. That of course over here on the trial balance as well. Note that we are increasing bad debt expense at this point in time that being the difference that then affecting net income, net income going down. We also want to remember that we will be recording something to the subsidiary ledger. This company's particular company owes us $30,000. We're going to decrease it down by $30,000 to $0,000 meaning they're not going to owe us anything anymore even though they only paid us $20,000. We're not going to leave the $10,000 there that they still owe us we gave up on it. And therefore I'm going to write the entire thing out down to zero. Contrasting that with the allowance method we still got the cash. We still got the receivables going down to zero. But instead of the $10,000 going to bad debt now it goes to the allowance for doubtful accounts. So we have the same effect on the accounts receivable $1,191,000 down by the 30,000 to $1,161,000. Same effect on the subsidiary ledger, the company going down to zero in terms of the subsidiary ledger 30,000 minus the 30,000 to zero. The difference being that there's no impact on the income statement, bad debt not being affected, no effect on net income. What is happening is we have this allowance account which was at $31,000 prior to this now going down by that 30,000 to the 21 remember that this 31 was there prior to this time period. It was there created from the prior time period based on an estimate and we created the bad debt expense based on either the revenue or the accounts receivable and then we closed it out. Of course that's why there's nothing in bad debt expense because it got closed out the end of the year or the end of the month and therefore is at zero and we're writing off the uncollectible receivables here that has already hit the income statement in our estimate. We estimated it prior to this, wrote it off in the prior time period, it then rolled into the capital account in the closing process and therefore is not on the income statement for this time period and we're just writing off the bad debt to the allowance account. We will have a bad debt won't happen however until we make an estimate at the end of the time period. If we compare and contrast the two then this is the bad debt, this is the allowance method, this is the direct write off method, this is the allowance method. We have no allowance for doubtful accounts, it's just there for demonstration, we're not using it under the direct write off method. We have 19,000 of people that we have determined will not be collectible and therefore wrote them off decreasing net income by that 19, the 378 minus the 19 bringing net income to net income of 359,000. We have the same receivable over here but then we have the allowance account, it's now going down to 21,000 because that's where we wrote off, the people that we have determined that would be uncollectible, no effect on bad debt, expense, no effect on the income statement from writing off these accounts thus far. Next one we're going to say receive payment from CW after writing it off. So this is that unusual one, it doesn't happen all that often in real life, we're going to first take a look at the direct write off method, this is a really good example problem though because it allows us to see the difference between the two methods and what would happen if we had to reverse a write off and so it makes us think kind of backwards which is great for testing and our knowledge on this type of stuff. So we wrote CW off, we said hey they're not going to pay us the 9,000 and then they came in even without our collection actions, we gave up collecting the money, they came in and paid us and that's great. So you would think that we would debit cash and credit some other account, we couldn't credit accounts receivable because we already wrote it off, we wrote it off in this case under the direct write off method to bad debt. So you would think we can just debit cash and credit bad debt but if we did so we wouldn't have it run through the receivable account and if we looked at the receivable subsidiary ledger it looks like this 9,000 is due to them not paying us and we want to show that they did pay us and therefore under either method we do need to reverse what we did prior to give us a paper trail that this client is good. So therefore we're going to reverse what we did last time under the direct write off method, we credited accounts receivable and we debit it bad debt, we're going to reverse that, going to put them back on the books increasing the accounts receivable by the 9,000, decreasing bad debt, unusual account here, bad debt and expense typically only going up with debits, this is an exception to the rule, we are reversing it under the direct write off method, this being the difference between the allowance and direct write off under the allowance method, this would be the allowance for doubtful accounts account. Once we do that then we can just do our normal transaction that would happen if a company came in and paid us on account, debiting the checking account, increasing the checking account, crediting accounts receivable, decreasing accounts receivable, note between these two journal entries here's accounts receivable, here's accounts receivable, debit credit doing the same thing, if we eliminate those two we're left with a debit to the checking account, credit to bad debt, so we could shorten this from just a technical standpoint to just this with one journal entry, but that doesn't give us a good paper trail therefore we don't do that, so if we post this then we're going to say accounts receivable is going to go back up by the 9,000 to this and then we're going to say that the bad debt is going to go down, here's the 9,000 here, we're now eliminating it and that brings us to the 10,000 down from 19 and then we have the cash account which is going to go from 120 up by the 9,000 to 129,000 and then we're going to have the second component which is going to be this item here, the accounts receivable going down bringing the 1 million 170 down by 9,000 to 1 million 161 that's where we're at now on the accounts receivable and the trial balance and then we got the subsidiary account and that's went from 0 it's going to go up by 9,000 to 9,000 and then we're taking it back down again down by 9,000 to 0 so the accounts receivable subsidiary account went from 9,000 credit back to 0 then we debited it by this 9,000 here bringing it back up to 9,000 and then we credited it by 9,000 this looks really repetitive because it just this is where we started and then it went up and then it went back down but this gives us a paper trail this item if we were to drill down on it would show that we got paid here whereas this item if we drill down on it would show that we gave up on the customer so that's the important difference between reversing this rather than just recording a debit cash credit to bad debt expense if we look at the allowance method same type of activity we're going to reverse what we did and then we're going to record the normal transaction the only difference here being this item when we first recorded the write-off we debited the we debited the allowance for doubtful accounts and credited the receivable now we're just reversing that so we debit accounts receivable just as we did under the direct write-off but instead of crediting the bad debt now crediting the allowance just reversing it then we're back in good standing and we can do the same thing that we did in the direct write-off method or the same thing we would always do when we receive cash on account debiting cash and increasing cash and decreasing with a credit accounts receivable so note here no effect on the net income the allowance account then is going to go back up from 21 up by the 9 to the 30,000 and that's because of course this individual did pay us so we're not taking it taking that down the accounts receivable account on the general ledger went back up and then went back down so we can see it just went up down same thing we put it back in and took it back out if we look at the CW account here this is where we started same thing his subsidiary ledger account for this customer goes back up by 9 and back down everything is the same except for this allowance account being the reversing account we're using not affecting the bad debt expense and the way to think of this is just to think about what do we do before and reverse it if we look at the comparison here's the direct write-off here's the allowance method direct write-off I'm showing the allowance account here but it's not used it's not being used here so that's why it's red it's not going to it's just a place holder and what we did was change the bad debt expense to write off or reverse what happened and then record our normal increase in the checking account and receivables under the allowance method we have the same thing except no effect on bad debt the adjustment that happened happened here in the allowance method increasing that allowance back up we will have the bad debt at the end of the time period when we make an adjustment under the allowance method these will be the major differences when recording the normal transactions for a an individual or customer that is determined to be uncollectible and when they pay us after we wrote them off going forward the allowance method will then have an adjustment in order to record the allowance for doubtful account based on either the revenue method here in terms of how much revenue was earned taking a percentage of that to determine what the bad debt would be matched up against that revenue or use a balance sheet method taking a look at the accounts receivable and determining how much of the receivable is going to be uncollectible either way it's better in terms of the matching method so the next step on the allowance method would be to determine in some way what the bad debt expense is not in the case not by knowing or finding out who is not going to pay us this time period from sales made in the past but instead making some type of estimate in terms of of this revenue made this time period how much of it will not be paid thereby matching up the expense to the related income in the same time period that estimate once again could be made either by looking at revenue taking some kind of percentage or some type of estimate based on the revenue earned at this time period this month this year or look at the balance sheet account and seeing how much of this we believe is going to be uncollectible that then get into the same number of bad debt but doing it in kind of a reversed type of way whatever we discern to decide is uncollectible whatever we have to adjust this allowance account to be the difference will be the bad debt expense here that will be matching up revenue and expenses