Compare and contrast the two methods of accounting for bad debt - direct write-off and the allowance method. What are the primary features of each method? What are the pros and cons to each method? What impact does each method have on the financial statements?
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There are two methods for recording bad debt:
1. The Direct Write-Off Method
2. Allowance Method.
Direct Write-Off Method:
The Direct Write-Off Method is not a good method because it does not apply the matching principle through which expenses are matched to revenues in the same period. This method records bad debt expense only when a company has given up its collection efforts and declares a specific account as uncollectible. For example, if a company granted credit for $1,000 in year 1 and after failing to collect that amount, in year 3, this account was written off. As a result, the year 3 was affected by an expense that in reality took place in year 1 but no one knew at the time. This ...
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