Question

In the real world of business, not all customers pay the balance they owe from purchases they made on account. Some customers' accounts receivable become uncollectible and must be written off by the company. Explain the two methods of accounting for uncollectible accounts. Which method is required by GAAP? Explain why.

Answer 1

Uncollectible accounts as the name indicates their is no chances to collect or recover certain amount of money lended due to reasons like bankruptcy,fraud or can't find that person to whom the money was lended.This is also termed as bad debt.The two methods that is used for accounting of such uncollectible accounts are- Direct Write-off method and Allowance Method.

1. DIRECT WRITE-OFF METHOD- it is also known as direct charge-off method.This method doesn't take into account the estimation off any uncollectable account and don't even prepare any account for it.This method violates the matching principle of generally accepted accounting principles which states expenses incurred during a period should be recorded in the same period in which the related revenues are earned and in this method the account receivable is written-off directly to expense only when the account proved as unrecoverable until then it assumes to be recoverable.

2. ALLOWANCE METHOD - It is basically estimation of the uncollectible amount before rather than realization on the day when it happens it follows the matching principle of generally accepted accounting principles.In this method the company prepares a a reserve account i.e Allowance for Doubtful Accounts..This method is used to adjust accounts receivable appearing on the balance sheet.

Allowance method is required by the GAAP because under this method uncollectable accounts are estimated and recorded to match revenues and expenses in a given period by following the matching principle.It enables estimated bad debt expense to be recorded in the same period as the credit sales.It is just an estimation that company use usually based on their past experience with bad debt this may not be entirely accurate.However it proves to be better than the direct write- off method.This method helps in getting the true value of accounts receivable.

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