 Hello and welcome to this session in which we'll discuss the in-collectible accounts. This topic is covered in intermediate accounting as well as the CPA exam. Specifically in this session we're going to be covering the direct write-off method. In the next session we would look at the allowance method. Now it's very important that you understand the direct write-off method in order to appreciate, to understand better the allowance method. Also the direct write-off method could be tested on the CPA exam and if not for anything it's tested for tax purposes. That's the tax purpose method for in-collectible accounts. So it's very important that you understand this topic. Whether you are an accounting student or a CPA candidate I strongly suggest you take a look at my website farhatlectures.com. I don't replace your CPA review course. I am a useful addition to your CPA review course. I provide you alternative explanation, alternative procedures. Your risk is one month of subscription. Your potential gain is passing the exam. Take a look at my website to find out how well or not well your university doing on the CPA exam. I do have other course catalogs such as advanced accounting, taxation, governmental accounting, intermediate accounting, so on and so forth. My CPA supplemental courses are aligned with your CPA review course such as Wiley, Roger, Gleam, Becker, so on and so forth and I do have access. I give you access to all the AI CPA released questions with detailed solution. Almost 1500 CPA questions in addition to my own CPA questions. If you have not connected with me on LinkedIn please do so. Take a look at my LinkedIn recommendation like this recording. Share it with other connect with me on Instagram, Facebook, Twitter and Reddit. So let's talk about in-collectibles account. Well account receivable is created, are created as a result of a sale. So what happened at the beginning? You make a sale on credit. You take a risk. You sell someone on credit and under the assumption they are going to pay you the money. And a perfect word here are the journal entries that we need for account receivable. We debit account receivable for $100. Let's assume we sold Ryan $100 worth of merchandise. We credit sales revenue for $100. So we bill Ryan $100 at some point in the future. Ryan will pay his bill for $100 and we are done. We created an account for Ryan. We Ryan paid the account and what's left is debit cash credit sales receivable. And this will be the end of the chapter for your receivable chapter. Well that's not the case. You know that's not the case because in the prior recording we dealt with sales returns and allowances and we dealt with sales discount. Sometimes Ryan is not happy with the product. They will return it. Sometimes they may pay early. We might give them a discount. There are much more involved. But in a perfect word this is what account receivable looks like. It's as simple as selling on account receiving the money. In this recording we need to discuss what happens when customers don't pay the balance for whatever reason or reasons. Now bear in mind you as an individual make sure to pay your balance otherwise your credit will be hammered. It's a little bit different for businesses because you and the business they might be two separate entities. The credit of the business might be hammered but not your credit. Your credit is very valuable. Okay don't not pay your bill. I'm not going to put too negative. Pay your bill. Okay make sure you do that because if you don't pay your bill your credit will be hammered. There are two methods to deal with this in collectible accounts. There is the direct write-off method which is not a gap method and this is what we will discuss in this chapter in this session sorry. And there's the allowance method. The allowance method is gap method. I'm not going to say it's difficult and I'm not going to say it's challenging. It's more involved that's all than the direct write-off method. So in this session we would look at the direct write-off method. What is the direct write-off method? What is that method? Well it's easy. You write off the account. You remove the receivable when the company determines the account is in collectible. It's as simple as that. Simply put the company decides they have a policy after a year of trying to collect the money. If we can't we write off the account based on certain criteria. That's it. Now this method is used for tax purposes. For tax purposes this method is acceptable and it's important to know it's acceptable for tax purposes because at some point you need to learn about the difference between financial accounting and tax accounting and this is going to be this is going to be one of the differences. As I said it's not gap. It's not accepted by gap for two reasons. One is the receivable is not stated at net realizable value. What's happened is this. Gap says you might have a million dollar of receivables but you have to tell us how much you expect to sell. So let's assume you only expect to I'm sorry how much you expect to collect. If you only expect to collect 950 you have to deduct what's called an allowance of 50. And this 950 is called net realizable value. In other words this is how much you expect to receive 950. Well the allowance at the direct write off method don't make this adjustment. So that's why it's not gap because gap says tell us how much you really go into collect net how much you really sold because you can sell a lot on account. You can open your door ask tell everyone I'm selling on credit. If you want to buy pay me later and everyone will buy from you. That's not what matters what matters is how much you can collect. That's one reason another reason why it's not gap it violates the matching principle and we're going to discuss this topic again in the next session. But simply put the matching principle says when you make a sale in a particular year if you make a sale on credit in year one this is the sale on credit in year one it has to be matched with the expense. What happened under the direct write off method? Assume you make a sale in year one you may not write it off until year two. Why? Because you are going to wait until you determine that the account is in collectible. So the sale in year one the expense in year two that's a violation of the matching principle. The sale should take place in year one and the expense should take place in year one and we'll see how the allowance method will fix this problem. I'm just explaining why the direct write off method is not gap. The direct write off method is accepted if the amount is immaterial. So if the amount is immaterial for certain companies in other words what is immaterial they don't expect to have in collectibles and if they have any in collectibles it's a very small amount. When you're dealing with government government always pay their bill. Let's assume the majority of your customers are government the federal government. You're not going to have in collectibles they're going to pay their bill right so it's not a big deal. But we will see in the next session how we can address those issues in the allowance method specifically why not gap specifically why those how we would address them fix that issue. So the best way to illustrate the direct write off method is to work a simple example it's as simple as that. You made a sale to Ryan for 100 dollars debit account receivable credit sales revenue. At the beginning I said in a perfect word what you would do is you debit after 30 days or 60 days you debit cash for 100 you credit receivable Ryan for 100 and life is life is over. Okay for the account receivable not for us okay now after repeated attempts we made calls mailing emailing we talked to Ryan in person Ryan failed fails to pay the bill. Okay by June 1st 26 20 x 6 so a year later that's the company the company determines that Ryan's account is in collectible. Now we don't tell Ryan right we keep trying to collect the money from Ryan that's it from our purposes it's useless to keep the receivable on the books. So what do we do at that point we will debit an expense called bad debt expense. Now remember this account bad debt expense. Now when do we debit that expense we debit that expense when we determine that the account for Ryan is in collectible so this is when we did it and the reason I'm emphasizing this the reason I'm highlighting this account because we're going to see it again in the next session when we use the allowance. In the next session the bad debt expense will be used under different circumstances. So we're going to debit bad debt expense 100 credit account receivable for Ryan 100 we were hoping rather than bad debt expense we were hoping that Ryan pays cash but that's not going to happen okay so now we wrote off the account and that's it we wrote off the account for Ryan so if we have a t account for account receivable notice we had initially a hundred dollar when we sold it then we credit the account $100 account receivable is zero life is over we're not going to sell Ryan anything on credit anymore that's how it works now let's assume Ryan sent a check August 5th for $100 so approximately a month later a couple months later june went by july went by August 5th suddenly we received a check in the mail for $100 excellent we're going to take the check we have two entries to make after we write off an account so this is when we write off the account this is write off this is when you write off the account and when we write off the account we have an expense remember i'm going to say this one more time when we write off the account we have an expense in the next session you're going to see something different okay so so under the direct write-off method when we write off the account that's when the expense takes place that's not going to be the case under the allowance method i'm just preparing you okay so let's assume Ryan send the check the first thing we do is we need to reverse the write-off so we need to reverse this entry reversing means to the opposite debit accounts receivable remember what we did first we had $100 then we write it off now we're going to put it back so this is the third $100 we're going to put it back on the books then we're going to accept the cash then we're going to take it off again and we're going to credit Ryan's account after we receive the money we receive the money so that's good at the end of the day Ryan paid his balance it took us a little bit long we wrote off the account to reverse it but that's the as complicated as it gets for the direct write-off method and this is all what you need to know then in the next session i'm going to talk about the incollectible method which will be a little bit different than the direct write-off method which it's going to be a gap method at the end of this recording once again i'm going to remind you whether you are an accounting student or a CPA candidate i can help you invest in your accounting career in your CPA exam take a look at my website farhatlectures.com for a nominal investment you can have access to resources that's going to help you pass the exam good luck study hard stay safe the CPA exam is worth it