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