Definition of Direct Write Off Method
Under the direct write off method of accounting for credit losses pertaining to accounts receivable, no bad debts expense is reported on the income statement until an account receivable is actually removed from the company's receivables.
Under the direct write off method there is no contra asset account such as Allowance for Doubtful Accounts. This means that the balance sheet is reporting the full amount of accounts receivable and therefore implying that the full amount will be converted to cash.
Reason Why the Direct Write Off Method is Not Preferred
The accounting profession does not prefer the direct method for the following reasons:
- The accounts receivable are more likely to be reported on the balance sheet at an amount that is greater than the amount that will actually be collected
- The bad debts expense resulting from having sold goods on credit will appear on the income statement only after the bad account is identified and removed from the company's accounts receivable. Hence, the bad debts expense is reported much later than would be the case under the allowance method.
[The Internal Revenue Service requires the direct write off method in order to prevent taxpayers from claiming a bad debts expenses based on an anticipated potential loss.]