Question

Under the direct write-off method, when is bad debt expense (uncollectible accounts expense) recognized? Under the allowance method, when is bad debt expense recognized? Name 1 reason why the direct write-off method is NOT allowed by FASB?

Answer 1

Solution:

Under the direct write off method , bad debt expense is recognised when a debtor's account is actually written off after determining that the particular balance is not collectible.

Whereas in the allowance method,a proportion of debt outstanding is determined which it anticipates will result in losses as a result of extending credit to customers.This amount is debited to income statement at the end of each year.

Allowance method is preferred over direct write off method by FASB because:

FASB's requires accurate financial reporting which is consistent with allowance method as it requires management to estimate bad debts prior to the time when account becomes uncollectible and report it in the income statement.And thereby reducing the amount of bad debts from outstanding debtors in the balance sheet it provides an accurate picture of the company.

Whereas in the direct write off method the entire debtors balance will be reported in the balance sheet which means that the assets will be overstated as whole of debtors are not collectible.It can also result in bad debt expense being reported in income statement in the year following the sale .For these reasons allowance method is preferred.