Financial Accounting

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Previous Lessons
Open Chapter Ch. 1: Basics of Financial Accounting
Lesson #1 Introduction to Financial Accounting
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Lesson #2 Structures of a Business
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Lesson #3 Comparing Internal vs. External Users
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Lesson #4 Business Activities
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Lesson #5 Financial Statements
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Lesson #6 Elements of Financial Accounting
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Open Chapter Ch. 2: Assets, Liability, and Equity
Lesson #7 Assets
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Lesson #8 Liabilities
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Lesson #9 Equity
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Open Chapter Ch. 3: The Double-Entry System and Conceptual Framework
Lesson #10 Accounting Equation
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Lesson #11 Conceptual Framework
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Lesson #12 Double Entry Accounting System
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Lesson #13 Debits and Credits
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Lesson #14 Normal Balances and RED Accounts
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Exam Exam 1
Open Chapter Ch. 4: The Accounting Cycle
Lesson #15 Journalizing and the Accounting Cycle
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Lesson #16 Posting to the General Ledger
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Lesson #17 Trial Balance
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Lesson #18 Adjusting Entries for Accrued Expenses
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Lesson #19 Adjusting Entries for Prepaid Expenses
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Lesson #20 Adjusting Entries for Unearned Revenue
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Lesson #21 Adjusting Entries for Accrued Revenue
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Lesson #22 Adjusting Entries for Amortization and Depreciation
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Lesson #23 Adjusted Trial Balance
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Lesson #24 Preparing the Financial Statements
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Lesson #25 Permanent vs. Temporary Accounts
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Lesson #26 Closing Entries
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Open Chapter Ch. 5: Merchandise Inventory
Lesson #27 Introduction to Merchandise Inventory
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Lesson #28 Periodic vs. Perpetual Inventory Systems
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Lesson #29 Journalizing Purchase Entries
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Lesson #30 Journalizing Sales Transactions
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Lesson #31 Preparing a Multiple-Step Income Statement
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Lesson #32 Periodic Inventory System Purchases
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Lesson #33 Periodic System and the Multiple-Step Accounting System
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Exam Midterm Exam
Open Chapter Ch. 6: Cost Flow Assumptions: FIFO, LIFO, and Average Cost Methods
Lesson #34 Specific Identification Method and Inventory Costing
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Lesson #35 FIFO Method and Inventory Costing
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Lesson #36 Average Cost Method and Inventory Costing
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Lesson #37 The LIFO Method
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Lesson #38 Average Cost Method for the Perpetual System
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Lesson #39 Comparing Inventory Costing Methods
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Open Chapter Ch. 7: Receivables and Bad Debts
Lesson #40 Allowance Method and Uncollectibles
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Lesson #41 The Allowance Method
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Lesson #42 Percentage of Sales Method
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Lesson #43 Percentage of Receivables Method
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Lesson #44 Receivables Method and the Aging Table
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Lesson #45 Write Off Receivables Using the Allowance Method
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Lesson #46 Direct Write-Off Method
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Open Chapter Ch. 8: Revenue Recognition
Lesson #47 Revenue Recognition
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Lesson #48 Revenue Recognition Examples
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Lesson #49 Revenue Recognition and Long Term Contracts
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Lesson #50 Percentage of Completion Method
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Lesson #51 Percentage of Completion Method Journal Entries
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Lesson #52 Percentage of Completion Method and Journalizing Losses
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Lesson #53 Cost Recovery Method
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Lesson #54 Completed Contract Method and Journal Entries
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Lesson #55 Completed Contract Method and Losses
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Exam Exam 3
Open Chapter Ch. 9: Depreciation of Fixed Assets and Gains and Losses
Lesson #56 Depreciation, Amortization and Depletion
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Lesson #57 Straight Line and Declining Balance Methods
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Lesson #58 Straight Line and Double Declining Balance Depreciation Examples
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Lesson #59 Gains and Losses on Disposals of Property, Plant & Equipment
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Open Chapter Ch. 10: Intangible Assets
Lesson #60 Intangible Assets
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Lesson #61 Amortizing Intangible Assets
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Lesson #62 Impairment of Intangible Assets
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Lesson #63 Recording Goodwill, Amortization and Impairment
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Open Chapter Ch. 11: The Indirect Cash Flow Statement
Lesson #64 Preparing a Cash Flow Statement Using the Indirect Method Part 1
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Lesson #65 Cash Flow Statement Using Indirect Method Part 2, Receivables
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Lesson #66 Cash Flow Statement Using Indirect Method Part 3, Inventory
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Lesson #67 Cash Flow Statement Using Indirect Method Part 4, Payables
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Lesson #68 Cash Flow Statement Using Indirect Method Part 5, Non Cash Expenses
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Lesson #69 Cash Flow Statement- Investing and Financing Activities
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Exam Final Exam

Assignments:

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Lesson Objectives:

- What the direct write-off method is
- Comparing the allowance method versus the direct write-off method
- Flaws of the direct write-off method



The direct write-off method differs significantly from the allowance method as we are not using an allowance for the amount of bad debt. This also means that we will not be making estimates, instead the company will directly write off the receivable when it occurs.

For example, if a company finds out that $5,000 worth of receivables will not be collected, they will need to record a journal entry to write off the bad debt expense. The bad debt expense of $5,000 would be debited and accounts receivable would be credited for $5,000.
 
Let's take a look at the negative aspects of using the direct write-off approach by comparing it to the allowance method.



With the allowance method, if the revenues for 2013 were $5,000 and the bad debt expense was estimated to be $2,000, the expense would be matched to the revenues in the same accounting period.
 
If the direct write-off approach was used instead, there would not be an expense entry in 2013. If two years were to pass by and the company determined they were not going to collect $2,000, the amount would then be written off in 2015. This is a direct violation of the matching principle as the expense is not matched to the revenue in the same accounting period.
 
This exemplifies why the allowance method is used under the IFRS and ASPE standards to calculate the bad debt expense adjustment. The direct write-off method is not allowed under the IFRS standards because of the fact it doesn't follow the matching principles.



Without using an allowance for doubtful accounts, the receivables will not have an accurate value for the amount in the receivables account.
 
If the receivables start at $8,000 and the AFDA allowance is estimated at $4,000, the net receivables would be calculated at $4,000.
 
With the direct write-off approach, there is no allowance for bad debts which means that the net receivables will be significantly overstated for that accounting period. When the receivable is finally deducted in 2015, the net realizable value would then be decreased to 4,000.
 
Take a look at the comparison above of how the AFDA estimate adjusts the net realizable value to an accurate value with the allowance method, while the direct write-off method wouldn't record the drop in the receivables value until years later.

While the NRV value would be consistent for the allowance method, it would take years for the direct write-off method to reflect the appropriate amount.
 
In summary, the direct write-off method doesn't fall in line with the matching principle and also doesn't yield a consistent net realizable value for receivables.
 
This lesson concludes our review of receivables and bad debts. In the next lesson, we will start talking about revenue and how it is recognized in the accounting world.