Under the direct write-off method a company writes off a bad account receivable after the specific account is found to be uncollectible. This write off usually occurs many months after the account receivable and the credit sale were recorded. The entry to write off the bad account will consist of 1) a credit to Accounts Receivable in order to remove the amount that will not be collected, and 2) a debit to Bad Debts Expense to report the amount of the loss on the company's income statement.
Under the allowance method a company anticipates that some of its credit sales and accounts receivable will not be collected. In other words, without knowing the specific accounts that will become uncollectible, the company debits Bad Debts Expense and credits Allowance for Doubtful Accounts. This Allowance account is a contra receivable account and it allows the company to report the net amount of the receivables that it expects will be turning to cash prior to identifying and removing a specific account receivable. When a specific customer's account does present itself as uncollectible, the customer's account will be written off by crediting Accounts Receivable and debiting Allowance for Doubtful Accounts.
In the U.S. the direct write-off method is required for income tax purposes. However, for financial reporting purposes the allowance method means recognizing the loss (the bad debts expense) closer to the time of the credit sales. As a result, the allowance method is more in line with the accountants' concept of conservatism and may result in a better matching of the bad debt expense with the credit sales.
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