Problem
What is the difference between the direct write-off method and the allowance method for receivables?
The Direct Write-Off Method will record bad debts expenses when the receivable from the customer is deemed uncollectable. This method is primarily used by small non-public companies. Under this method bad debt expenses are recorded to cover the accounts that won't be received due to non-collection.
The Allowance Method uses the matching principle, meaning that they will record their bad expenses in the same period as the sales revenue for the transaction. This method basically estimates what bad debts expenses they will have prior to customers not paying. A contra account is used to offset the expense which is called Allowance for Bad Debts which is subtracted from Accounts Receivable. The Allowances for Bad Debts will act as a pool for the unknown accounts that fail to pay. A big difference between the Allowance and Direct Write-Off method is that when there is an uncollectible account the Direct Write-Off method records a debit to Bad Debts Expense and in the Allowance method it debits the Allowance for Bad Debts
Prepare the journal entry to write off an account using the direct method.
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Date
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Accounts and Explanation
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Debit
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Credit
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July 21
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Bad Debts Expense
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1600
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Accounts Receivable-Halpert
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1600
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Wrote off an uncollectible account
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Prepare the journal entries using the allowance method to establish the allowance and the write off of an account.
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Date
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Accounts and Explanation
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Debit
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Credit
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Jun 30
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Bad Debts Expense
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5000
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|
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Allowance for Bad Debts
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5000
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Recorded bad debts expense for the period
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|
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Date
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Accounts and Explanation
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Debit
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Credit
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Jul 21
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Allowance for Bad Debts
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1600
|
|
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Accounts Receivable-Halpert
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5000
|
|
Wrote off an uncollectible account
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|
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