Question

1. How are bad debts accounted for under the direct write-off method? What are the disadvantages of this method?

Answer 1

Under the direct write-off method, bad debts expense is reported on the income statement of the company when a customer's account is actually written off. This occurs months after the credit sale was made and a Journal entry is made

Bad Debts Expense a/c ..... Dr

Accounts Receivable a/c ...... Cr

Direct write off method includes charging bad debts to expense only when individual invoices have been identified as uncollectible.

The method does not involve a reduction in the amount of recorded sales, only the increase of the bad debt expense.

Also, there is no contra asset Account that is Allowance for Doubtful Accounts.

Disadvantages of above method :

1. Violates Matching Principle : The matching principle requires a business to record revenues and their related expenses in the same accounting period, however this principle is violated as the expense is recorded only when the account is written off.

2. Overstated Accounts Receivables : As no contra asset account is present the Debtors reported are higher on the Balance Sheet.

3. Manipulated Earnings or Inaccurate Profits : Bad debt expense occurs in a later period than its related revenue sometimes due to which a company’s profits on its income statement might be inaccurate.

4. Potential for Abuse

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