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Direct Write-Off Method

Moneyzine Editor
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Moneyzine Editor
2 mins
January 16th, 2024
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Direct Write-Off Method

Definition

The financial accounting term direct write-off method refers to an uncollectible accounts receivable process that records bad debt expense in the same accounting period the company determines the debt will never be collected. The direct write off method is typically used when calculating income taxes owed.

Explanation

Unfortunately, not all customers that make purchases on credit will pay companies the money owed. There are two methods companies use to account for uncollectible accounts receivable, the direct write-off method and the allowance method.

The direct write-off method does not involve estimates of bad debt expense. Instead, it relies on reports of accounts receivable the company has determined will not be collected. If write off is not material, this method can be used in financial reports. Typically, it's restricted to income tax purposes since the IRS allows the company to deduct bad debts expense once a specific uncollectible account has been identified.

The allowance method records an estimate of bad debt expense in the same accounting period as the sale. The allowance method is used to adjust accounts receivable in financial reports. Since it will often take months for companies to identify specific uncollectible accounts, the direct write off method violates the matching principle, which requires companies to match expenses with revenues in the same accounting period.

When a company identifies a specific accounts receivable that will not be collected, the direct write-off method requires a journal entry that credits the account receivable and records a corresponding debit to bad debts expense.

Example

Company A has attempted to collect $6,350 from Company XYZ for several months. Company A's collection department has been informed that Company XYZ has gone out of business, and they have instructed the process owners to write off the amount owed.

For income tax purposes, the journal entry to account for this write-off would be:

Date

Account

Debit

Credit

3/31/20XX

Bad Debts Expense

$6,350

Accounts Receivable: Company XYZ

$6,350

Write off of Company XYZ

Related Terms

  • Balance Sheet
    Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
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  • Matching Principle
    The matching principle is a financial accounting term that refers to a standard, which states that revenues generated in an accounting period need to be matched with the expenses incurred in that same accounting period.
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  • Current Assets
    The financial accounting term current assets is generally defined as cash and other assets that can be converted into cash within one year or one operating cycle, whichever is longer. Current assets are a subcategory of assets, which appear on a company's balance sheet.
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  • Accounts Receivable (Receivables)
    Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.
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  • Accounts Receivable Valuation
    The term accounts receivable valuation describes the methods used to determine the value of accounts receivable appearing on the company's balance sheet. Typical adjustments to accounts receivable can include discounts, sales returns, and uncollectable accounts.
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  • The term uncollectible accounts receivable is used to describe the portion of credit sales in accounts receivable the company does not expect to collect from a customer. Uncollectible accounts is used in the valuation of accounts receivable, which appears on a company's balance sheet.
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  • Allowance Method
    The financial accounting term allowance method refers to an uncollectible accounts receivable process that records an estimate of bad debt expense in the same accounting period as the sale. The allowance method is used to adjust accounts receivable appearing on the balance sheet.
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