Understanding the Two Methods to Write Off Uncollectible Accounts

📊The allowance method, which complies with GAAP, estimates the portion of receivables that will be uncollectible and reports it as an allowance for doubtful accounts.

📉The direct write-off method, which doesn't comply with GAAP, writes off uncollectible receivables as they become certain, without any estimation.

💰The allowance method matches revenue and expenses by estimating bad debt expense each reporting period.

💸The allowance method reduces accounts receivable to its net realizable value, reflecting the amount the company expects to receive in cash from its receivables.

💡The direct write-off method does not provide a matching of revenue and expenses, as uncollectible receivables are only recorded when they become certain.

What is the difference between the allowance method and the direct write-off method?

—The allowance method estimates the portion of receivables that will be uncollectible, complies with GAAP, and matches revenue and expenses. The direct write-off method writes off uncollectible receivables as they become certain but doesn't comply with GAAP and doesn't provide a matching of revenue and expenses.

Why is the allowance method considered more compliant with GAAP?

—The allowance method is considered more compliant with GAAP because it involves estimating bad debt expense each reporting period and reducing accounts receivable to its net realizable value, reflecting the amount the company expects to receive in cash from its receivables.

How does the allowance method match revenue and expenses?

—The allowance method matches revenue and expenses by estimating bad debt expense each reporting period based on the company's prior collection experience and other relevant factors.

What is net realizable value?

—Net realizable value is the net amount the company expects to receive in cash from its receivables. In the allowance method, accounts receivable is reduced to its net realizable value by creating an allowance for doubtful accounts.

What is the main advantage of the allowance method?

—The main advantage of the allowance method is that it provides a better matching of revenue and expenses by estimating bad debt expense each reporting period and reducing accounts receivable to its net realizable value.

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00:08There are two ways to write off uncollectible accounts: the allowance method and the direct write-off method.

00:15The allowance method is compliant with GAAP and involves estimating the portion of receivables that will be uncollectible.

00:24The allowance method matches revenue and expenses by estimating bad debt expense each reporting period.

00:46The allowance method reduces accounts receivable to its net realizable value, reflecting the amount the company expects to receive in cash from its receivables.

01:05The direct write-off method writes off uncollectible receivables as they become certain, without any estimation.

01:23The direct write-off method doesn't provide a matching of revenue and expenses.

02:17The percentage of sales method and the aging of receivables method are two popular methods for estimating bad debt expense.