Allowance for Doubtful Accounts

question 160

Essay

Allowance for doubtful accounts.
When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible. As a result of this, a company must recognize bad debt expense. There are basically two methods of recognizing bad debt expense: (1) direct write-off method, and (2) allowance method.

Instructions

(a) Describe fully both the direct write-off method and the allowance method of recognizing bad debt expense.
(b) Discuss the reasons why one of the above methods is preferable to the other and the reasons why the other method is not usually in accordance with generally accepted accounting principles.

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Definitions:

Cash Realizable Value

The amount of money that can be received from assets or receivables through normal collection processes.

Allowance Method

A method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period.

Credit Sales

Sales made by a business where payment is delayed as per agreed terms, allowing the buyer to purchase goods or services on credit.

Allowance for Doubtful Accounts

A financial account used by companies to account for the percentage of accounts receivable that may not be collected due to customer defaults.