Question

How is the allowance method of accounting for bad debts different from the direct write off method? Which is the preferred method? Why?

In what ways are accounts receivable similar to a note receivable? How are they different?

Why might a company choose to issue a note receivable over an account receivable?

Answer 1

1) In case of allowance method the bad debts are not directly reduced from the accounts receivable, an account of doubtful allowance is opened and bad debts are routed through this account and than deducted from accounts receivable while in case of direct write off method the bad debts are directly deducted from accounts receivable. The allowance method is preferred since the company would know how much allowance has been created for the debtors till date.

2) Note receivable and accounts receivable are similar in terms as both are due for sales made to customers and both have credit period given to customers to make payment. In case of notes receivable the firm receives interest payment for the credit period while in case of accounts receivable no interest is charged by the firm. Generally when customer is not able to pay accounts receivable within credit period it converts the same into notes receivable for further extension of credit period and pays interest during this extension period of credit.

3) The firm would preferred notes receivable over accounts receivable due to the interest earned during the period also the firm can discount the notes in case it needs fund immediately.