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What is the direct write-off method?

Author:
Harold Averkamp, CPA, MBA

Definition of Direct Write-off Method

The direct write-off method is one of the two methods normally associated with reporting accounts receivable and bad debts expense. (The other method is the allowance method.)

Under the direct write-off method, bad debts expense is first reported on a company’s income statement when a customer’s account is actually written off. Often this occurs many months after the credit sale was made and is done with an entry that debits Bad Debts Expense and credits Accounts Receivable.

With the direct write-off method, there is no contra asset account such as Allowance for Doubtful Accounts. Therefore the entire balance in Accounts Receivable will be reported as a current asset on the company’s balance sheet. As a result, the balance sheet is likely to report an amount that is greater than the amount that will actually be collected. It can also result in the Bad Debts Expense being reported on the income statement in the year after the year of the sale. For these reasons, the accounting profession does not allow the direct write-off method for financial reporting. Instead, the allowance method is to be used for the financial statements.

However, the direct write-off method must be used for U.S. income tax reporting. Apparently the Internal Revenue Service does not want a company reducing its taxable income by anticipating an estimated amount of bad debts expense (which is what happens when using the allowance method).

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.

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