Question

The Board of Directors has asked you to explain the method used to handle uncollectible Accounts Receivables. They know that you use the Allowance Method but are not familiar with the difference between the Direct Method versus the Allowance Method. Using the textbook as a source, explain each type of method and why ABC Company has selected the Allowance Method. Download the memo template provided below to respond. Keep in mind the intended audience of the memo.

Answer 1

To:
From:	ABC
Date:	7/30/2019
Subject:	Methods used to handle Uncollectible Accounts rEceivable

Direct write off

Direct write of method does not use allowance account as bad debt expenses are recognized when the accounts actually becomes uncollectible. So no allowance account is created under this method. It violates matching principle where cost related to the revenue are charged to the expense In the same period in which it is incurred. It is only appropriate where the amount is immaterial else this method should not be used.

Whereas in allowance method we estimate uncollectible accounts at the end of the period. It follows GAAP matching principle where expense is recognized in the period in which revenue is earned. There are two approaches that can be used one is:

1) Aging method (Balance Sheet approach)

This method ages receivable according to the time duration for which the accounts receivable becomes due and assigning % according to time duration.

2) Percentage of sale method (Income statement approach)

It directly calculates bad debt expense as percentage of sales amount.

An contra asset account is created name allowance for doubtful accounts which decreases accounts receivable to Net Realizable Value. When there is an amount which is actually uncollectible than Accounts Receivable is Dr and allowance for doubtful accounts is credited. Bad debt expenses adjusting entry is made at the year.

ABC company must select Allowance method as it follows GAAP matching principle and provide more accurate results in terms of income statement.