What is the 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 much later than the time of the sale.) When the account is written off, the account Bad Debts Expense will be debited and Accounts Receivable will be credited.

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. This means that 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 accounting year following the year of the sale. For these reasons, the accounting profession does not allow the direct write-off method for financial reporting. Rather, the allowance method is to be used for the financial statements.

However, the company must use the direct write-off method for its U.S. income tax return. 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 occurs when the allowance method is used).