Which of the following is a method of accounting for uncollectible accounts

Unfortunately, some sales on account may not be collected. Customers go broke, become unhappy and refuse to pay, or may generally lack the ethics to complete their half of the bargain. Of course, a company does have legal recourse to try to collect such accounts, but those often fail. As a result, it becomes necessary to establish an accounting process for measuring and reporting these uncollectible items. Uncollectible accounts are frequently called “bad debts.”

Direct Write-Off Method

A simple method to account for uncollectible accounts is the direct write-off approach. Under this technique, a specific account receivable is removed from the accounting records at the time it is finally determined to be uncollectible. The appropriate entry for the direct write-off approach is as follows:

Notice that the preceding entry reduces the receivables balance for the item that is uncollectible. The offsetting debit is to an expense account: Uncollectible Accounts Expense.

While the direct write-off method is simple, it is only acceptable in those cases where bad debts are immaterial in amount. In accounting, an item is deemed material if it is large enough to affect the judgment of an informed financial statement user. Accounting expediency sometimes permits “incorrect approaches” when the effect is not material.

Recall the discussion of non bank credit card charges above; there, the service charge expense was recorded subsequent to the sale, and it was suggested that the approach was lacking but acceptable given the small amounts involved. Materiality considerations permitted a departure from the best approach. But, what is material? It is a matter of judgment, relating only to the conclusion that the choice among alternatives really has very little bearing on the reported outcomes.

Consider why the direct write-off method is not to be used in those cases where bad debts are material; what is “wrong” with the method? One important accounting principle is the notion of matching. That is, costs related to the production of revenue are reported during the same time period as the related revenue (i.e., “matched”).

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With the direct write-off method, many accounting periods may come and go before an account is finally determined to be uncollectible and written off. As a result, revenues from credit sales are recognized in one period, but the costs of uncollectible accounts related to those sales are not recognized until another subsequent period (producing an unacceptable mismatch of revenues and expenses).

To compensate for this problem, accountants have developed “allowance methods” to account for uncollectible accounts. Importantly, an allowance method must be used except in those cases where bad debts are not material (and for tax purposes where tax rules often stipulate that a direct write-off approach is to be used). Allowance methods will result in the recording of an estimated bad debts expense in the same period as the related credit sales, and generally result in a fairer balance sheet valuation for outstanding receivables. As will soon be shown, the actual write-off in a subsequent period will generally not impact income.

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Did you learn?Be able to apply the direct write-off method.Know the deficiencies of the direct write-off method.Understand the general impact of the allowance methods for uncollectible accounts.Know why an allowance method is preferred over the direct write-off approach.

The Internal Revenue Service requires use of this method for the reporting of taxable income in the United States since it believes (perhaps correctly) that companies might otherwise be tempted to inflate their bad debt reserves in order to report a smaller amount of taxable income.

The Direct Write-Off Method of Accounting

Under this method, the account receivable is written off by creating a credit memo for the customer in question, which equals the amount of the bad debt. A credit memo debits an account for bad debt expenses and a credit account for accounts receivable. In this method, there is no reduction in the amount of recorded sales, only an increase in bad debt expense.

For instance, a business records a sale on credit of Rs. 10,000 by debiting the accounts receivable account and crediting the sales account. As a result, the seller has to write off Rs.2,000 to the accounts receivable account and offset the debit to the bad debt expense account. The seller can only collect $8,000 of the open balance after two months, so the seller must write off the balance over two months.

This results in the revenue amount remaining the same, the remaining receivable being eliminated, and a bad debt expense being created.

Limitations of the Direct Write- Off Method

• Direct write-offs violate the matching principle, which stipulates that all costs associated with revenue are applied to expenses in the same period in which revenue is recognized, so the financial results of an entity encompass the full extent of a revenue-generating transaction at the end of the year.
• Direct write offs delay the recognition of some expenses associated with a revenue-generating transaction, so it is considered an excessively aggressive accounting method, since it delays some expense recognition, making a reporting entity appear more profitable in the short term than it actually is.
• If a company sells $1 million in sales, it may wait three or four months to collect all the related accounts receivables, and then charge off some bad debts as an expense. It results in a long delay between revenue recognition and the recognition of expenses relating to that revenue. As a result, the profit in the first month is overstated, whereas the profit in the month when the bad debts are finally charged to expenses is understated.

  What are the methods of accounting for uncollectible accounts?

  ¨ Credit losses are debited to Bad Debt Expense (or Uncollectible Accounts Expense). ¨ Two methods are used in accounting for uncollectible accounts: (1) the Direct Write-off Method and (2) the Allowance Method. § When a specific account is determined to be uncollectible, the loss is charged to Bad Debt Expense.

  Which of the following methods of accounting for uncollectible accounts matches sales with the bad debts expense?

  In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time.

  Which one is not a method in accounting for uncollectible accounts?

  Under generally accepted accounting principles (GAAP), the direct write-off method is not an acceptable method of recording bad debts, because it violates the matching principle. For example, assume that a credit transaction occurs in September 2021 and is determined to be uncollectible in February 2022.

  Which of the following methods and bases of accounting for uncollectible accounts receivable is inconsistent with the proper application of matching?

  Which of the following methods and bases of accounting for uncollectible accounts receivable is inconsistent with the proper application of matching? the expense of a bad debt is not matched to the period that generated the uncollectible sale amount.