Question

1. Compare and contrast the direct write-off method and the allowance method for bad debts.

• At a minimum, please consider the following in your answer:
  • When is the expense for uncollected accounts receivable recognized under each method?
  • Why is the direct write-off method not considered to follow generally accepted accounting

Answer 1

Solution:

Comparison between direct write off method and the allowance method for bad debts:

1. Write off the amount of bad debts:

Under direct write off method, the estimated amount of bad debt is immediately considered as a loss, and write off from the amount of account receivables.

Whereas under allowance method , the estimated amount of bad debts is considered as a probable future loss and does not write off as expense immidiately.

2. Recording as expense or provision:

Under the direct write off method, bad debts are recorded as expense in income statement and the amount is also write off from the account receivables.

Whereas under the allowance method, the estimated amount of bad debts is recorded as a provision .

and is shown as a provision in the income statement and reduced as provision from the amount of debtors in the balance sheet.

3. Timing of recognition of expense:

Under the direct write off method , the bad debts are recognised as expense immidiately in the year of its estimation.

Whereas under the allowance method , expense of bad debts is recognised in the year, when account receivables actualy become uncollectible.

4. Acceptability under Generally Accepted accounting:

Direct write off method of recording the uncollectible amount of accounting receivables , is not an acceptable method under GAAP (Generally Accepted Accounting Principle).

But the allowance method is generally used in accounting.

Reason of non acceptance of direct write off method under GAAP. :

under the direct write off method , bad debts expense account is debited, and account receivables account is credited.

Thus bad debts are immediately recognised as a loss or expense in the year of estimation itself .

whereas the actual uncollectability may be certain only in the future years,

Because the amount of the uncollectable account receivables are just the estimated amounts ,

and it is not correct to immediately write off the amount as bad debts expense,

But should be write off only in the year when the Uncollectability of that amount is certain.

Finish.