Direct write-off method and Allowance method
Allowance method and direct written method definition and journal entries
The Direct write off method
Under the direct write off method, collectible account expense account or bad debt expense has been declared in uncollectible. In other words, the bad debt is occurred the accountant records it in a financial statement.
Related journal entries:
Uncollectible expense a/c Dr. xxx
Account receivable a/c xxx
(To record the uncollectible expense)
Allowance method:
When the seller can make a reasonable estimate of the rupee amount to be written off, the allowance method should be used. The allowance method provides an expense for uncollectible receivables in advance of their write off. The use of the allowance method serves two purposes. First, it reduces the value of the receivables to the amount of cash expected to be realized in the future. Second, it matches the uncollectible expense of the current period with the related revenues of the period.
Under the allowance method, bad debt or uncollectible expense is estimated at first and recorded accordingly. When actual bad debt occurs it is adjusted with the estimated uncollectible expense account. There are different methods for estimating uncollectible expense account. Some important of them are:
Despite these different methods of calculation of estimated uncollectible expense amount the method of recording them in journal entries are the same.
Journal entries
i. When allowance for uncollectible expense or bad debt or doubtful debt is estimated
Uncollectible expenses a/c Dr. xxx
Allowance for uncollectible expense a/c xxx
(To record the estimated allowance for uncollectible expense)
ii. When actual bad debt has occurred
Allowance of uncollectible expense a/c Dr. xxx
Account receivable a/c xxx
(To record the uncollectible expense written-off)
iii. When uncollectible expense written-off is recovered
Account receivable a/c Dr. xxx
Allowance for uncollectible expense a/c xxx
(To record the reverse of uncollectible expense written off)
Cash a/c Dr. xxx
Account receivable a/c xxx
(To record the collection of cash)
Example:
A Company has annual sales amounting to Rs. 5,00,000 and 60% of the total sales are on credit. The company estimated 20% of the credit sales as an uncollectible expense.
The account receivable amounting to Rs. 10,000 from XYZ Company is recorded as an uncollectible expense.
The previously written off amount of uncollectible expense from XYZ company is now recovered. Prepare necessary journal entries.
Solution:
Total sales amount = Rs. 5,00,000
Credit sales = 60% of 5,00,000 = Rs. 3,00,000
Estimated amount of uncollectible expense = 20% of 3,00,000 = Rs. 60,000
Journal entries
i.
Uncollectible expense a/c Dr. Rs. 60,000
Allowance for uncollectible expense a/c Rs. 60,000
(To record the allowance for uncollectible expense)
ii.
Allowance for uncollectible expense a/c Dr. Rs. 10,000
Account receivable – XYZ Co. a/c Rs. 10,000
(To record the uncollectible expense from XYZ Company written off)
iii.
Account receivable – XYZ Co. a/c Dr. Rs. 10,000
Allowance for uncollectible expense a/c Rs. 10,000
(To record the reverse of uncollectible expense written off)
Cash a/c Dr. Rs. 10,000
Account receivable – XYZ Co. a/c Rs. 10,000
(To record the cash collected from XYZ Company)