More on the Direct Write Off Method
Following the rules laid down by the direct write off method, you will have to report any bad debts on your income statement regardless of whether you are doing so as an individual or on behalf of a small business or company. This is done when the customer who caused you the bad debt's account is finally written off.
This typically happens months after the credit sales was generated. Writing-offs can be a long and winding process, so it's important to keep yourself updated with any advancements in a certain ex consumer's bad debt case.
As the person responsible for handling this bad debt, it is your responsibility to enter the loss into your Bad Debts Expense book and credit it to your Accounts Receivable.
In the direct write off method, there is no contra asset account (Allowance for Doubtful Accounts book). As a result, everything in the Account Receivable book will be counted as a current asset on the company or individual's balance sheet.
Stemming from this, the balance sheet may end up reporting a value that is higher than the amount said individual or company is actually going to end up collecting. This can create disturbances in the overall accounting process, so professional accounting firms do not prefer using the direct write off method.
Provision or Allowance Method
This is the second method used by accountants to write off a bad debt that has resulted from a company or individual that sold goods based on credit but never received any payment for it, not will they receive a payment in the future.
Under the allowance or provision method, the individual mentioned above or company will record an adjusting entry at the end of every accounting period for the number of losses anticipated due to credit extension towards their customers.
This type of entry will include the operating expense account (Bad Debts Expense) as well as the contra-asset account (Allowance for Doubtful Accounts)
In the future, when a specific account receivable is finally written off as "uncollectable," the individual or company's account debits Allowance for Doubtful Accounts and credits the Accounts Receivable.
Professional accountants prefer employing this method over the direct write off method for a number of important reasons:
- The income statement will account for the bad debts expense nearer to the time the sale or service was granted.
- The sales balance sheet will report a more realistic net amount of account receivable that will eventually be converted into actual cash and be credited to the individual or company's account.
This method of bad debt write-offs can be applied in the following ways:
- You can focus on the bad debt expense that is needed on the income statement.
- You can focus on the balance needed in Allowance for Doubtful Accounts; this will be reported on the balance sheet.
Final Words
As you can see, there are two prominent methods one can employ when attempting to write off bad debt. The first method, the direct write-off, is simpler but not appreciated as often.
Hence, even though it is slightly more complicated, it's better if you opt for the second method, provision for doubtful debts, to get a more accurate representation of your final financial gains. If you need any help with this, reach out to the experts at Hall Accounting Company to guide you through this process.
