Accounts receivable represent amounts due from customers when a business provides credit terms and sells to them on account.
Inevitably some of the amounts due will not be paid and the business will need to have a process in place to record these bad debts.
Journal Entry for the Direct Write-off Method
One method of recording the bad debts is referred to as the direct write off method which involves removing the specific uncollectible amount from accounts receivable and recording this as a bed debt expense in the income statement of the business.
Suppose a business identifies an amount of 200 due from a customer as irrecoverable as the customer is no longer trading. If the amount is not collectible, it needs to be removed from the customers accounts receivable account, and this is achieved with the following direct write-off method journal entry.
|Bad debt expense||200|
In this example, the credit entry removes the bad debt from accounts receivable and reduces the amount due from the customer, and the debit entry records this as an expense in the income statement reducing the net income of the business.
The accounting equation is as follows.
Problems with the Direct Method
The direct write-off method is easy to operate as it only requires that specific debts are written off with a simple journal as and when they are identified. The problem however, is that under generally accepted accounting principles (GAAP), the method is not acceptable as it violates the matching principle. Using the direct write-off method revenue might be recorded in one period, when the customer is invoiced, whereas the expense of writing off the uncollectible amount is recorded in a completely different period , when the amount is identified as irrecoverable.
As a result of this the direct write-off method can only be utilized when the debts written off are immaterial, when the matching concept can be overridden by the materiality constraint.
Note: This is in contrast to the allowance method in which an estimate of the cost of the uncollectible receivable is recorded in the same period in which the revenue is recorded.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.