The risk of overstating and understating expenses in the income statements is also minimized. There are remote chances of error, considering no calculation of estimates of doubtful debts is required.read more compilations are also avoided if this method is used. When we add the balances of these two assets, we will get the net book value or carrying value of the assets having a debit balance. The contra asset account Contra Asset Account A contra asset account is an asset account with a credit balance related to one of the assets with a debit balance.The other advantage is that the company can write off its bad debts on its annual tax returns.Companies only have to pass two journal entries for the amount of the customer’s bad debt. The main advantage of the Direct Write-off method is that it is straightforward to book and record in books of accounts.The firm partners decide to write off these receivables of $ 5,000 as Bad Debts are not recoverable. The firm then debits the Bad Debts Expenses for $ 5,000 and credits the Accounts Receivables for $ 5,000. The firm is taking regular follow-ups with the Company’s directors, to which the directors are not responding. The remuneration has been outstanding for a year now. read more as per the laws in force and hands over the Financial Statements to its directors in return for a Remuneration of $ 5,000. These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. Example #2Īn accounting firm prepares a company’s financial statements Financial Statements Financial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). Using the direct write-off method, Natalie would debit the bad debts expenses account by $ 1,500 and credit the accounts receivable account with the same amount. After trying to contact the customer a number of times, Natalie finally decides that she will never be able to recover this $ 1,500 and decides to write off the balance from such a customer. One of her customers purchased products worth $ 1,500 a year ago, and Natalie still hasn’t been able to collect the payment.
Natalie has many customers who purchase goods from her on credit and pay. Reasons Why Direct Write-off Method is not preferred in the Accounting Profession?Įxamples of Direct Write-Off Method Example #1Īssume Natalie owns a shop of confectionery.This means that, regardless of when the actual transaction is made, the expenses that are entered into the debit side of the accounts should have a corresponding credit entry in the same period. It is probably against the matching principles Matching Principles The Matching Principle of Accounting provides accounting guidance, stating that all expenses should be recognized in the income statement of the period in which the revenue related to that expense is earned. It is because the expenses are recognized in this period. read more of income in the current period. A company adopts strategies to reduce costs or raise income to improve its bottom line. It affects only the bottom line Bottom Line The bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. It does not affect the sales performance of the entity in the current period and the previous period. The write off amount is debited as the expense in the period approved to write off in the income statement Income Statement The income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements. There is no recording of the estimates or use of allowance for the doubtful accounts under the write-off Write-off Write off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets. The direct write-off method is used only when it is inevitable that a customer will not pay. Bad Debts Expenses for the amount determined will not be paid directly charged to the profit and loss account under this method.