Question

Please explain the diference between the Direct Write off method and Allowance Method of writting off a receivable.  

Answer 1

Usually the company sells the products or provide services to customers on account or credit basis. So these customers sometimes fail to give the whole amount and therefore there is a situation occurs for the company to provide for these uncollectible amounts in their records. Usually there are two methods for handling uncollectible accounts which are direct write off method and allowance method.

Under direct write off method, it recognized bad accounts as an expense at the point when judged to be uncollectible and is the required method for federal income tax purposes.

Under allowance method, it provides in advance for uncollectible accounts think of as setting aside money in a reserve account.

In direct write off method, the company adopt this method when the company decide a customer will not pay. Here, no estimates are made for uncollectible accounts. So bad debt expense will be the amount that customer will not pay. So the entry will be a debit to bad debt expense and a credit to accounts receivable.

In allowance method, it follows GAAP matching principle as the company estimates uncollectible accounts at end of year. This helps to setup a reserve account called allowance for doubtful account based on past due accounts. So at end of year, company will estimates the amount and entry will be a debit to bad debt expense and credit to allowance for doubtful accounts. And when the customer is to be write off, then debit the allowance for doubtful account and credit accounts receivable.

SUMMARY:

Under direct write off method, no estimates are made but under allowance method, an estimate is made. That is, when a customer did not pay a certain percentage of amount for one or two years, the company will think that this year also that customer will not give that certain money and will estimate based on past due accounts.