Question

There are times when businesses cannot collect the money that is owed to them by their customers. When this happens, businesses incur an expense. There are two methods for recording uncollectible receivables. They are the allowance method and the direct write off method. Please explain the difference between these two methods.

Answer 1

Under the direct write off methodology, a corporation doesn't anticipate debt expense. Rather, it waits till associate degree account is truly written off as invalid before recording debt expense. this suggests its assets are going to be reported on the record at their full amounts—implying that every one of the assets are going to be turning to money. If there's some doubt regarding the collectibility of a number of the assets, the assets area unit doubtless immoderate and also the company's profit is doubtless overstated. Since there's sometimes a big quantity of your time between a credit sale and also the write off of a foul account, the debt expense can occur in a very a lot of later amount than the revenue from the sale. this is often a issue under the matching principle.

The accounting profession prefers the allowance methodology over the direct write off methodology as a result of the assets are going to be given on the record with a discount known as the allowance for uncertain accounts. this suggests internet quantity of the assets are going to be lower and nearer to the quantity that may truly be collected. debt expense is reported at the time that the allowance for uncertain accounts is made and adjusted. Hence, the debt expense is reported nearer to the time of the credit sale.

It ought to be noted that the inner Revenue Service needs the direct write off methodology. they like to ascertain the write-off for debt expense only associate degree account due is truly written off—as against allowing a deduction for associate degree anticipated potential loss.