Discussion:
Review the youtube video on Bad Debts (Allowance Method, Direct Write Off) and discuss the primary advantages and disadvantages of applying the direct write-off over the allowance method of writing off accounts. Take a position on whether estimating the allowance for doubtful accounts provides the opportunity to distort gross income. Provide support for your rationale.
Brief Reply 100 words: Please read and respond to the post of another student below:
Direct write-off method:
An advantage of using the direct write-off method is that it is simple. Companies only have to make one transaction for the amount of the customer's bad debt. Another advantage is that companies can write off their bad debt on their annual tax returns. When debt is determined as uncollectible, a journal entry is passed in which bad debts expense account is debited and accounts receivable account is credited.
A disadvantage of the direct write-off method is the possibility of expense manipulation, because companies record expenses and revenue in different periods. Therefore, companies should only use this method for small amounts that do not significantly impact financial records. Another disadvantage is that the balance sheet is not an accurate representation of the company's accounts receivable. Also, this method is not accepted by GAAP and so should not be used.
Allowance method:
An advantage of the allowance method is that it follows the matching principle which allows for accurate financial records. Another advantage of the allowance method is that the balance sheet accurately reports accounts receivable, which benefits investors and management. When a debt is recognized as uncollectible, a journal entry is passed in which bad debts expense account is debited and allowance for doubtful debt account is credited. When the debt becomes actually uncollectible then allowance for doubtful debt account is debited and accounts receivable account is credited.
A disadvantage is that management may inaccurately estimate write-offs by a large margin, which can cause companies to misstate net income.
A disadvantage is that management may inaccurately estimate write-offs by a large margin, which can cause companies to misstate net income.
Gross income:
The allowance for bad debts is not true figure since it is just an estimate of the amount of accounts receivable that the company will not be able to collect. So the figure allotted for bad debt can affect the gross income.