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Bad Debts Direct Write-off Method

By Yuriy Smirnov Ph.D.

Definition

The direct write-off method is a widely used technique for bad debts accounting. Under this method, the specific account receivable is written off to the expense directly when it is identified as uncollectable.

Please note that using the bad debts direct write-off method is not permitted under GAAP (Generally Accepted Accounting Principle) and IFRS (International Financial Reporting Standards). Instead, GAAP and IFRS require that companies use the allowance method to report credit losses.

The allowance method, though, is prohibited from being used by many tax authorities around the globe for tax reporting purposes. For example, the Internal Revenue Service in the U.S. requires that companies use the direct write-off method for income tax reporting.

Journal Entries

Under the bad debts direct write-off method, one entry is required to record credit loss in the general journal. If it is known that a specific customer is not able to pay a specific amount, the accounts receivable should be reduced for that amount. It is recorded by debiting the Bad Debts Expense account and crediting Accounts Receivable.

Journal entry to record credit loss under direct write-off method

Recovery of Bad Debts

To recover accounts receivable, write-off made in the previous period requires two entries to be made in the general journal.

Journal entry to recover bad debts under direct write-off method

The first entry is the reverse of the bad debts write-off entry previously made. It is recorded by debiting Accounts Receivable and crediting the Bad Debts Expense account for the amount of cash collected.

The second entry debits the Cash account and credits Accounts Receivable for the same amount.

Examples

RetailX LTD uses the bad debts direct write-off method for tax reporting. In the 3rd financial quarter, the following transactions were made:

If RetailX LTD had used the direct write-off method in financial accounting, entries in the general journal would be as follows:

Direct write-off method journal entries example

The record made on July 13 recognizes bad debts written off in the amount of $1,850. The records made on September 21 recognize the recovery of bad debt of $2,400 written off in the 1st financial quarter.

Advantages and Disadvantages

Advantages

  1. The advantage of the direct write off method is simplicity. It requires fewer entries to be made than under the allowance method.

Disadvantages

  1. The biggest drawback of the direct write-off method is violating the matching principle of accounting. The accounting period in which a credit loss is recognized can vary from the period these sales were actually made. In other words, the credit loss could not properly match the related sales.
  2. The value of accounts receivable can be understated because doubtful accounts are written off only when they are identified as uncollectable.
  3. This method is not permitted for use under many financial accounting standards, including U.S. GAAP and IFRS.