Question

Debtors 'balance is considered one of the most important asset accounts in commercial companies, and this balance is shown in the budget after deducting part of the balance in order to meet the possibility of not collecting any of the debtors' accounts, and that is through an estimate dedicated to doubtful debts, and the accountant may rely on several methods to calculate and estimate them, as well as It takes into account the bad debts, what is the best method in evaluating debtors, the direct write-off method or the provisions method? Why? Explain

Answer 1

There are 2 ways to account for bad debt expense. The fundamental difference between the 2 methods is in timing difference of bad debts expense recognition and accounting principles applied for accounting bad debt expense. Hence both methods are not same and the recommended method for accounting is allowance method. A direct method of write off is not in accordance with conceptual framework for financial reporting as explained below.

Direct write-off method: This method accounts for bad debts based on actual bad debts generated in business that is when customer is unable to pay and it is confirmed that customer dues is a bad debt For example: A court order is passed for customer insolvency is a confirmation of bad debts expense. In this case the bad debts are debited to Income statement and credit is given to Accounts receivable. This method is not in accordance with accrual concept and matching concept since bad debts are not accrued for each period and bad debts of different period can be charged to sales of different period.

Allowance method: This method considers the percentage of allowance on Accounts receivable balance during the period and accounting is done through an Allowance for uncollectible receivables. The bad expense is calculated as percentage of closing Accounts receivable balance. A bad debts expense is debited and credit is given to allowance for uncollectible receivables. Only when the customer dues are confirmed as bad debts it is debited to Allowance for uncollectible receivables account and credit is given to accounts receivable account. This method is in accordance with accrual concept and matching concept since bad debts are accrued in the period in which sales take place and bad debts expense match the sales recognised in the period. The Accounts receivable is shown at Gross minus allowance for uncollectible account to show its net realisable value in Balance Sheet.

Allowance method of bad debts write off is preferred over direct method as per conceptual framework for Financial Reporting. The allowance method is recommended since it gives true and fair view of financial statements because it is in line with accrual concept and matching concept of financial reporting framework