Unit 2: accounting for receivables introduction

1.4.2 Direct Write-Off Method

Under the direct write – off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is charged to Bad Debts Expense.

To illustrate, assume that Warden CO. writes off M.E. Doran’s Br.200 balance as uncollectible on December 12. The entry is:

Dec.12 Bad Debts Expense - - - 200

Accounts Receivable – M.E. Doran – 200
(To record write – off M.E. Doran account)

When this method is used, bad debts expense will show only actual losses from uncollectible. Accounts receivable will be reported at its gross amount.

Under the direct write – off method, bad debts expense is often recorded in a period different from the period in which the revenue was recorded. Thus, no attempt is made to match bad debts expense to sales revenue in the income statement or to show the cash realizable value of the accounts receivable in the balance sheet. Consequently, unless bad debts losses are insignificant, the direct write – off method is not acceptable for financial reporting purposes. The direct write – off method is however, used for tax purposes. The Inland Revenue allows a tax deduction for uncollectible accounts only when specific accounts receivable are deemed uncollectible.

Review Exercises 1. What are the essential features of the allowance method? 2. Explain the difference between the percentage of sales and the percentage of receivables methods? 3. What term describes the balance sheet valuation of accounts receivable less the allowance for doubtful accounts? 4. The ledger of ABC Co at the end of the current year shows Accounts Receivable of Br. 92,500. The analysis of the accounts in the customers’ ledger indicates uncollectible accounts of Br.8010. (the company uses the percentage of receivable method) Record the adjusting entry under the following assumptions. (a) The allowance for doubtful account before adjustment has a debit balance of Br. 510 (b) The allowance for doubtful account before adjustment has a credit balance of Br. 800

5. Assume DDB Co. determines on January 23 it can’t collect Br. 520 owed to it by its customer AKK. Co. Record the adjusting entry using the direct write-off method.