Accounting for Advanced Accruals

6.4 Direct write-off method of accounting for bad debt

Besides the allowance method, there is also another way of accounting for bad debts. This method is called a direct write-off of bad debts:

Direct write-off method of accounting for bad debt is the practice of recording bad debt expense when a particular account is determined to be uncollectible. No allowance for bad accounts is recorded at the end of each period under this method. Receivables write-off is recorded directly in the bad debt expense account in the income statement.

There is no need for estimates, adjusting entries, or use of the allowance for doubtful accounts under this method.

Direct write-off method is employed only when the amount of uncollectible receivables is immaterial (e.g., insignificant to the users of financial statements). Under this method bad debt expense is recognized at the point an account receivable is known to be uncollectible. In such a case, accountants skip allowance for doubtful accounts and record the expense directly to the appropriate expense account in the income statement (Bad Debt Expense). Accounts receivable are reduced by the same amount as the increase in bad debt expense.

6.5 Illustration of accounting for bad debt expense under direct write-off method

Let's look at an example. Suppose, in 20X7 Collin's Company provided services on account for $100,000. The transaction acts to increase assets and equity:

Illustration 6-16: Effect of revenue recognition in the horizontal model

Assets	=	Liab.	+	Equity	Rev.	-	Exp.	=	Net Inc.	Cash Flow
100,000	=	n/a	+	100,000	100,000	-	n/a	=	100,000		OA

In 20X8 Mr. Collin found out that one customer, who owed $500 for services provided in 20X7, is not able to pay the amount due. In this situation, the uncollectible amount is not material (compare $500 to $100,000). So, Collin's Company can use direct write-off even though the revenue (in 20X7) does not match with the related bad debt expense (in 20X8). The direct write-off decreases Accounts Receivable and increases Bad Debts Expense:

Illustration 6-17: Effect of receivables direct write-off in the horizontal model

Assets	=	Liab.	+	Equity	Rev.	-	Exp.	=	Net Inc.	Cash Flow
(500)	=	n/a	+	(500)	n/a	-	(500)	=	(500)		n/a

General journal entries are presented below:

Illustration 6-18: Journal entries for the receivables direct write-off

Event No	Account titles	Debit	Credit
1	Accounts Receivable	100,000
	Service Revenue		100,000
2	Bad Debts Expense	500
	Accounts Receivable		500

6.6 Definition and explanation of warranties

In today's business world one method of attracting customers is warranties.

A warranty is the seller or manufacturer's promise to do something for a customer (repair, exchange, refund) about a bad or broken product during a specified time period without additional charges (for free).

Even though warranties represent an uncertainty in time, amount, or customer, they are usually deemed as an obligation and must be recorded in financial statements. The following example deals with warranties and how they are accounted for in the books.

Page 6 of 9

Back Next