 In this presentation, we will be discussing the direct write-off method. The direct write-off method asset relates to accounts receivable. Quick summary of accounts receivable. Accounts receivable is a current asset. It's an asset with a debit balance. We are going to be writing off certain amounts for accounts receivable that will become not do or not collectible at some point in the future. There are two ways to do this. One is called the allowance method. The other is the direct write-off method. We will be using the direct write-off method here. The non-generally accepted accounting principles method, being this direct write-off method. However, a method that is typically much easier to use. Therefore, when considering whether or not to use an allowance method or direct write-off method, we want to consider one. Do we have to use an allowance method due to the fact that we need to make our financial statements in accordance with generally accepted accounting principles? Or are we able to choose between having an allowance method or direct write-off method? If we choose to have a direct write-off method, it's probably because we're thinking that the receivables that will be written off are not significant. In other words, they're non-material to decision making. So if we had our accounts receivable here, that's what people owe us. We want that on the books to represent the fact that we do have an asset. We do have people owing us this money. However, if there's a significant amount that we believe will not be paid to us, then we want to note that if we don't, we're overstating our assets and we're also distorting our net income on the income side of things. So the deciding factor then is going to be, one, do we have to use an allowance method that will be a generally accepted accounting principle? If we have to make financial statements in accordance with a strict rule in generally accepted accounting principles, then we would typically need an allowance method unless the amount was in material. If we're not required to be recording our books with regard to the allowance method because of generally accepted accounting principles, the question then is, should we be recording the allowance method? Is it better for decision making that decision basically again coming down to whether or not it's going to be material to decision making? How many of those receivables we believe will not be collectible? As we go through the direct write-off method, we always want to compare it to the allowance method to see the differences between the two methods. We have this account here, this red account that will not be used as we go through this direct write-off method, but there to show us what would be there if we were to use an allowance method to compare and contrast as we go through this process. So first we're going to say that a customer CW is not going to pay us the accounts receivable of 9,000. For whatever reason at this point in time we've decided we're not going to get paid and therefore we're going to have to decrease our accounts receivable. And the decrease is going to be a credit to accounts receivable. Accounts receivable is a debit balance asset account. We're going to do the opposite thing to it to make it go down because we're not going to get paid. Therefore our journal entry will be a credit to accounts receivable. That will be the same under the allowance method or the direct write-off method. The other side is what will differ. Under the direct write-off method we will write it off to bad debt expense. This is probably what seems most natural at this point in time because it's not getting paid so we're going to write it off to bad debt expense. What actually happened here, how did that accounts receivable get on the books in the first place? We debited accounts receivable and we credited revenue when we made the sale. You would think then that we would decrease revenue at the point in time that we discover that the sale $9,000 worth is not valid. We're not going to get paid that $9,000. But we don't typically reduce revenue one and therefore we're going to make this other account that's going to kind of be like a contra revenue account because we never really earned revenue bad debt expense. It's going to be an expense where really kind of taking away revenue that we had recorded in the past. The problem with this method of course is that when we record this expense we will be reducing net income at this point in time when really the sale that happened that increased revenue happened in the past. That's a timing problem that we have. Not so good timing in terms of the direct write off method here. Let's see if we post this then. We're going to post this to the general ledger accounts here. Then we'll record it to the subsidiary ledger. So we're going to say that the bad debt is going to go up. Here's the general ledgers, the two accounts. We're not going to show all the accounts for the general ledger. Every account here on the trial balance would of course have a general ledger account showing the detail by date. That means it's going to go up from zero by 9000 to 9000. That's going to be the new balance. Here's the accounts receivable. It started at 1,200,000. There's the 1,200,000, well it was 1,200,000 before this. Now we're going to bring it down by the 9,000 to 1,191,000. There's the 1,191,000 now on trial balance after this transaction has happened. We also need to record this to the accounts receivable subsidiary ledger. So we know that CW is the individual that didn't pay us. We note that the accounts receivable over here on the trial balance and here on the general ledger show who owes us money, how much is owed to us. The GL gives us detail, but only by date. The subsidiary ledger would then give us detail about who owes us this money. We're just going to show the account for CW here, but in a subsidiary ledger we would be having all the accounts owed, all the customers, owing us money. And if summed up then it would add up to the amount on the trial balance. So in this case CW owes us that 9,000. We're going to say that they're not going to pay us. We're going to take it out of the subsidiary account and that will bring it down to zero. Note the major problem and difference here between the two methods is that under this method, the direct write-off method, we brought net income down by this 9,000. We had revenue 378 minus this 9,000. We just recorded bringing net income, the subtraction of those two to 369,000. Under the allowance method, we would have recorded that through the allowance account that we would have already set up, not decreasing net income at the point in time that we determined that something will not be due, but having already done so or estimating what the decrease will be trying to match up the bad debt expense to the revenue that it was actually incurred in rather than waiting until we determine when something is uncollectible. Note that we have a lot of control over net income in some ways if we're able to then decide when we think something is going to be a bad debt because we can write things off at certain times or wait and not write them off and that could have a significant influence on the net income. On the other hand, if we are forced to basically make an estimate of how much we think of this revenue will be uncollectible, then we'll at least have to give a guess as to what we think a fair number would be that would be uncollectible related to the revenue earned during this time period. Next transaction we're going to say that G company had a payment of 20,000 but owed us 30,000. In other words, of this receivable, this $1,191,000, G company owes us 30,000 but they're going to go bankrupt or something happened, we're only going to get to 20,000, we're not going to get to rest. We can imagine they're growing bankrupt, we're going to get 20,000 in the bankruptcy, the 10,000 is something that we're not going to get, we're going to write it off. Therefore we can say okay cash went up just like a normal payment on account, cash is a debit balance, we're going to make it go up by doing the same thing to it, another debit 20,000. Then we're going to credit the accounts receivable, the accounts here of course saying that they owe us money, it's going to go down because they don't owe us money anymore, this is a debit balance account and therefore it goes down with the opposite of a debit or a credit. However, we're not going to credit the 20,000 but the 30,000, the total owed to us so that we totally remove the amount that's owed to us off the books. Our debits do not equal our credits now, we need a debit of 10,000, that then is going to go under the direct write off method to bad debt expense. This is what will differ under the two methods under the direct write off method it goes to bad debt expense, under the allowance method it would be going to the allowance for doubtful accounts. So this is going to be the same type of transaction we had before, only difference being that we received a partial payment. So don't let that throw you off if you see a partial payment, then we're still going to go through our normal transactions, we're going to say is cash affected, yeah, we're going to increase the cash. Then just note that you have to take the receivable off but not for the amount received but for the entire amount because we're not going to get the rest therefore needing to remove the full amount owed by this customer so we don't show that they still owe us 10,000, they don't owe us anything anymore because we gave up on the other 10,000, then we have to decide how we're going to even this thing out, we do so with another debit. If we then post this to our general ledger accounts over here and our subsidiary ledger and then we'll take a look at our Indian trial balance, we're going to say that cash is going up from 100,000 by this 20, so we post that to the GL account increasing the GL to 120,000, that of course will now match our trial balance after we post that. Then we're going to say the accounts receivable, this 30,000 credit, we had 1,191, here it's going down by 30, to 1,161, that then matches what will be on the trial balance. Then the bad debt here, the thing that will differ, the bad debt changing as we determine that something will not be collectible going from 9,000, here's the 10, here's the 10 going up by 10 to 19,000, that then the amount in the bad debt on the trial balance. Note once again that the revenue is going, well the net income is going down, bad debt is going up, it's bringing net income down, that's going to be a difference that the major difference between the direct write off method and the allowance method. For the allowance method, this journal entry would not be affecting net income, net income would only be affected when we make an estimate about what the bad debt should be, not based on when it is becoming bad, but based on matching it to the revenue in the same time period. We can do that with two different methods, we'll talk about in a later point, but remember that the allowance method should have a better matching principle between the revenue and the bad debt happening in the same time period. Then we have the accounts receivable subsidiary ledger, remember that the accounts receivable here represents how much is owed to us but doesn't give us any more detail than that, the accounts receivable here gives us detail but only by date of transaction, we need the detail by who owes us money, that's going to be the accounts receivable subsidiary ledger, we're only going to look at this particular customer here, this customer G company, but all the customers we remember would be included in this subsidiary ledger, if we added up all customers it would then add up to the accounts receivable on the trial balance and on the general ledger. We're going to say we covered the same thing, this 30,000 goes here and that's going to bring the balance down to zero, so that's critical, we know that G company doesn't owe us any more money, they paid us 20 even though they owed us 30, we took the entire 30 off the books not leaving that 10,000 still owed to us because we gave up on it and therefore need to take the entire 30 off the books bringing them down to zero. Next transaction, we're going to say received a payment from CW after writing it off, this is going to be a typical book type transaction not so typical when we have a real life situation because if we wrote off the bad debt, we totally gave up on it, so we gave up on the bad debt and that doesn't normally happen until we go through a pretty significant collection process and then after we gave up on it, we're not calling it anymore, we're not actively trying to collect on it, it then gets paid at some point in the future. How do we deal with that? That's a great book question because it really emphasizes the difference between the two methods and how are we going to kind of reverse this transaction. Now this is going to be the trickiest thing that we have here because typically if we got paid, you would think that we would debit cash and then we would credit what we know we wrote it off to bad debt, so you would think, okay, I wrote it off to bad debt, I can just credit bad debt, so typically we would go through our questions, is cash affected, yeah, I debit cash and then the other side can't go to receivable because I wrote it off, well where did we write it off to, bad debt. So we could debit cash and credit bad debt, however, we're not going to do that and this is kind of an exception to the rule of dealing with cash first and that is because if we do that we bypass the accounts receivable and we don't have a record showing us that in the receivable account in the subsidiary ledger for this customer that they actually paid it. What we want to do is put them back in good standing on the receivable account and then write it off as we normally would. Therefore we're going to do this with two transactions, two entries, we're going to put them back on the books, we're going to say the receivable is going to go back up, we wrote off the receivable, we're reversing the write off and then we're going to put the other side to bad debt expense meaning when we wrote it off we credited the receivable to take it down and under the direct write off method we put the other side to bad debt expense. We're just reversing that now, we're going to put the debit to accounts receivable and the credit to bad debt just reversing the write off that happened because it didn't really happen because they actually paid us so we gave up on them too soon. Note that this bad debt expense is part of the reversal and part of the difference that would be between the two methods. Under the allowance method this amount would have been written off to the allowance and therefore would be reversed now to the allowance. Once we do that then the second piece is easy because it's our normal transaction. We got paid on account, the accounts receivable is back in good standing therefore we're going to say it's cash affected, yeah it's a debit, we're increasing cash with a debit so it's a debit to cash and then we're decreasing the receivable which we just increased by the nine thousand. So again we could simplify this transaction, you can look at this and say hey we're duplicating information, I mean I've got accounts receivable here and I've got accounts receivable here and it's just doing the same thing, once being debited, once being credited I could eliminate those two, if we just eliminate these two we would be left with a debit to the checking account and a credit to the bad debt. The problem once again is that we want to see the paper trail in accounts receivable. We want to be able to go to the accounts receivable subsidiary ledger and say yeah this person paid us, we're willing to do business with them in the future, we can't see that if we don't reverse the transaction and then put it through the subsidiary ledger. Let's take a look at recording this then, we're going to say first the accounts receivable is going to go back on the books so we took them off the books here in the subsidiary ledger back on the books in the receivable increasing the amount to one million one hundred and seventy here. Other side and that's all that's there right now, other side it's going to go to the bad debt, bad debt is being reversed here so here's the bad debt that we wrote off incorrectly, we gave up on it too soon, we are reversing it here at this point in time bringing the nineteen down by the nine to the ten thousand then we're going to record the second piece which is just the normal transaction for a receipt on account receiving money for the accounts receivable for something that we did in the past. So here's the cash going up, here's the cash going up and that brings the balance from one twenty to one twenty nine and then the other side of it is going to be the accounts receivable here, it's going to be the credit, here's the credit. So note what happened, we started before this process in the receivable general ledger at one million one sixty one and then we brought it up putting them back in good standing and back down to bring it back to that same spot one million one sixty one thousand. We'll see that same process in the subsidiary ledger, the subsidiary ledger for CW remember we had nine thousand we gave up on them wrote them off left leaving us at zero and then ignore this nine thousand here we're at zero at this point in time and then we have the other side of it is going to be a debit to the accounts receivable so the accounts receivable is going up with this nine thousand putting them back on the books so we took them down to zero put them back on the books at nine thousand bringing us back up to a nine thousand balance that's from this transaction and then we're just going to take it right back off the books for the accounts receivable for CW here so CW another nine thousand bringing the balance back down to zero so if we look at the subsidiary ledger remember that this would be a subsidiary ledger with every account for every customer however we're just looking at CW's subsidiary ledger they had nine thousand owed to us we wrote it off in the past prematurely we should not have done so because this was still a good customer they just paid late very late apparently and so we brought it down to zero and then we want to see that we put them back in good standing here so that we can see the paper trail bringing them back up to only this nine thousand and then we record they paid us if we look at this payment then it still brings us down to zero but we can look at this payment say well how did we get paid and see that they actually gave us money whereas if we looked at this transaction we just left it here and we didn't record the other two we would drill down on that transaction and say well they didn't pay us and that would probably stop us from doing business with them in the future we want to say they're back in good standing and they paid us here therefore we can still do business in the future notes the effect here is going to be on the bad debt the bad debt is now going down and that's going to be a difference between the allowance method and the direct write-off method where the allowance account would be the account affected there would be no effect to the net income or the income statement accounts at all under the allowance method whereas under the direct write-off method of course bad debt is affected and it would then bring bad debt going down bringing that income up