In: Accounting
Allowance for doubtful accounts. When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible. As a result of this, a company must recognize bad debt expense. There are basically two methods of recognizing bad debt expense: (1) direct write-off method, and (2) allowance method. Instructions Describe fully both the direct write-off method and the allowance method of recognizing bad debt expense. Discuss the reasons why one of the above methods is preferable to the other and (a) (b) the reasons why the other method is not usually in accordance with generally accepted accounting principles.
Direct write off method-
This method is based on actual occurance of bad debts.Under this method the accounts receivable is directly reduced to income statement if such account is not collectible.
The following journal entry is passed -
Bad debt expenses Dr.
Accounts Receivables Cr.
The bad debts expenses is charged directly to income statement.
No, provision is created in this method for expected uncollectibles.This method runs based on actual uncollectibility.
Allowances method-
Under this method, estimation is done on the basis of prior years experiences and then the bad debts are recognised in advance.
The following journal entry for provision is made-
Bad debts expenses Dr.
Allowances for doubtful debts Cr.
And when the account becomes actaully uncollectible then,these accounts are write off from these allowances for doubtful debts as follow-
Allownaces for uncollectibles Dr.
Accounts Receivables Cr.
Explanation-
The allowances method is treated the best method which complies with matching principle of accounting and are accepted in most of the GAAP's.
The direct write off method is prima facia non compliance of matching principle,which requires company to match the expenses from income of same period.Hence this method is not accepted by GAAP's.
Please comment for any explanation,
Thanks