Question

1) What generally accepted accounting principle is being implemented when a company estimates its potential credit losses from its outstanding accounts receivable?

2) Why is the direct write-off method of accounting for credit losses not generally accepted?

Please answer both questions please!

Answer 1

1. As per Generally Accepted Accounting principles :-

When a company estimates potential loss of credit out of its outstanding accounts receivable, then the company will create a provision for doubtful debts.

This provision is charged into profit and loss statement.

in simple words we can say that as per Generally accepted accounting principles if any company estimates any loss from outstanding account receivables then to that extent that company will create a provision on the name of "provision for bad for doubtful debts" and this provision will be charged against profit and loss.

2. Reasons for direct write off method of accounting for credit losses not Generally accepted.

As per Generally accepted accounting principles. In that they have laid a process for recognition of doubtful debts and write off doubtful debts. That is as follows :-

A. Classify all the outstanding receivables on the basis of ageing analysis.

B. Analyse how many account receivables are older than 90 days aur over the normal credit period

C. In general sense, outstanding account receivables are said to be defaulted they are unpaid in the expiry of 90 days or experience normal credit terms.

D. Every company has to create a provision for outstanding account receivables which are considered as default in the above point D.

E. After classifying of those outstanding account receivables as default then also no amount recovered from those type of account receivables then rate of those account receivable from already created provision in the above point E.

This is the reason why direct write off is not Generally accepted.

These are all the information required to solve the given questions.

I hope, all the above mentioned information and explanations are useful and helpful to you.

Thank you.