The Direct Write Off Method: Pros & Cons (2024)

FAQs

The Direct Write Off Method: Pros & Cons? ›

Direct write off method disadvantages

It goes against the matching principle: According to the matching principle in accounting, expenses must be reported in the same period that they were incurred. Bad expenses might not be recognized until later on with the direct write-off method, which would lead to a mismatch.

Direct write off method disadvantages

It goes against the matching principle: According to the matching principle in accounting, expenses must be reported in the same period that they were incurred. Bad expenses might not be recognized until later on with the direct write-off method, which would lead to a mismatch.

The main advantage of the Direct Write-off method journal entry is that it is straightforward to book and record in books of accounts. Companies only have to pass two journal entries for the amount of the customer's bad debt.

Benefits of the Direct Write-Off Method

The Internal Revenue Service (IRS) requires companies to use the direct write-off method in their returns because it is an exact method. The allowance method of estimating the amount of debt in an accounting period isn't permitted by the IRS.

Now total revenue isn't correct in either the period the invoice was recorded or when the bad debt was expensed. This distortion goes against GAAP principles as the balance sheet will report more revenue than was generated. This is why GAAP doesn't allow the direct write off method for financial reporting.

In the direct write-off method of accounting for delinquent invoices, bad debts are only recorded on the income statement when it is determined that the money owed cannot be recouped. This violates the matching principle. Matching principle states that income and costs should be recorded at the same time.

Recording bad debts through the direct write-off method affects only the bottom line of income in the current period. It does not affect the sales period. The direct write-off method is mandatory for U.S. Income Tax reporting. Bad debts can be deducted from the total taxable income while filing the annual tax returns.

Companies write off bad debts to maintain accurate accounting records. That's because this method uses the actual amount not paid instead of a mere estimate. As a result, it is much easier to resolve missing or incomplete payments.

Better Insights. Another advantage of the direct method is the specificity and insights it provides compared to the indirect method. Since the direct method simply utilizes all cash-based transactions to prepare the operating cash flow section, the calculations are simple, straightforward, and easy to follow.

What is wrong with the direct write-off method of accounting for bad debts? ›

The direct write-off method does not match expenses against revenue very well is correct because the estimated bad debts are not recorded in the same period the sales are recognized. Instead, bad debt is only recorded when an individual account becomes uncollectible.

The allowance method can be better for a business than the direct write-off method because: The bad debts expense closer to the point of the sale or service. The allowance prepares a more accurate estimation of end-of-period financials, so the business knows what they have and how to prepare.

The direct write-off method involves writing off a bad debt expense directly against the corresponding receivable account. Therefore, under the direct write-off method, a specific dollar amount from a customer account will be written off as a bad debt expense.

Advantages of the direct write-off method

The direct write-off method is considered an easy way to deal with bad debts because you only need to make two transactions—one to the bad debts expenses account and the other to accounts receivable for the amount the customer owes.

Importance of the direct write-off method

Bad debt is any outstanding amount that a customer cannot pay off on time. By utilizing this method, small businesses can debit the bad debts they've incurred into the expense account and they can credit accounts receivable.

One disadvantage is that it can be difficult to track all of the different materials that go into each product. This can make it hard to determine the true cost of production. Another disadvantage is that using direct materials can tie up a lot of cash in inventory.