Overview of Direct Write-Off Method
The direct write-off method is one method for accounting for bad debts. It expenses bad debts only at the time specific accounts are determined to be uncollectible. In other words a company waits until an account proves to be uncollectible before it reports the bad debt expense and reduces accounts receivable.
Under the direct write-off method, bad debt expense is often recorded in a different period from that in which the related revenue was recorded. Accordingly, the direct write-off method generally fails to match revenues with expenses.
The direct write-off method is used to record uncollectible accounts by many small businesses that do not require audited financial statements. The direct write-off method is also used by larger companies when the amount of accounts receivable is not significant to the financial statements. Therefore, the users of the financial statements will not be misled with regard to accounts receivable shown in the financial statements.
One deficiency with use of the direct write-off method is that receivables are always presented at their full amount, rather than the amount a company expects to collect from those receivables. The amount a company expects to collect from its receivables is known as net realizable value and is an important concept in the presentation of receivables.
Journal Entries for Direct Write-Off Method
When an account is deemed uncollectible because of a customer's inability to pay, under the direct write-off method, a journal entry must be made to write off that account balance. An accountant will record a debit to bad debt expense and a credit to accounts receivable. On occasion an account that has been written off will be paid by the customer. At the time the payment is received, two entries are required. The first entry is to reinstate the customer's account balance. To record the reinstatement, record a debit to accounts receivable and a credit to bad debt expense. The second entry is to record the cash receipt. The payment is recorded as a usual payment on account is recorded: debit cash and credit accounts receivable.
Consider that Fusco BodyWorks sells automobile parts to McIntyre Motors Company on account. As of January 31, 2018, McIntyre's balance owed to Fusco was $25,000. Since it had not made any payments on the account since September 1, 2017, Fusco decided the McIntyre account was uncollectible. Fusco made a entry to write off the whole account balance of $25,000.
Write-Off of Bad Debt Entry
|January 31, 2018||Bad Debt Expense||$25,000|
|To record write-off of McIntyre Motors account|
Under the direct write-off method, when a company receives payment from a customer whose account was previously written off in the same year, two journal entries are required. The first entry is to reinstate the account receivable by recording a debit to accounts receivable and a credit to bad debt expense. The second entry is to record the cash received by recording a debit to cash and a credit to accounts receivable.
On July 31, 2018, Fusco BodyWorks received $25,000 from McIntyre Motors for full payment of its balance from January 31. Fusco made journal entries to record the reinstatement of the receivable and to record the cash receipt.
Reinstatement of Account Receivable Entry
|July 31, 2018||Accounts Receivable||$25,000|
|Bad Debts Expense||$25,000|
|To record the reinstatement of McIntyre Motors' previously written-off account|
Cash Received for Payment of Previously Written-Off Account Entry
|July 31, 2018||Cash||$25,000|
|To record the receipt of full payment for McIntyre Motors' previously written-off account|