Financial Accouting Course. Please don\'t copy the answer from somewhere else, I

Question

Financial Accouting Course. Please don't copy the answer from somewhere else, I need a unique answer to avoid plagiarism?

Q1. 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 carefully 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 IFRS.

Explanation / Answer

DIRECT WRITE OFF METHOD

In the direct write-off method, uncollectible accounts receivable are directly written off against income at the time when they are actually determined as bad debts. When debt is determined as uncollectible,

It Violates Matching principles, what happens is for Example Sales for$20 Lakhs is made at the end of Accounting year, say some where near ending 2017, And there arises a Bad debt of $ 1 lakh in begining of 2018, but the bad debt was pertaining to sales made at the year end 2017

Typically the Journal Entry woud be

Bad Debt Expense Dr $1 Lakhs

To Accounts Receivable $1lakhs

What is happening is the Bad debts expense is made for the current year, but should have been of the prior period expense

direct write-off method would cause deduction of expenses of previous period against revenue of current period which is contrary to the matching principle of accounting

IN ALLOWANCE METHOD

Here instead of Creating a Debt expense, Provision to the extent amount unrealisable is created

So what happens is there is no P& L expense recognised and provision is created, advantage of using this method is if the amount becomes realisable subsequently an reverse entry can be made nullfing the effect of provisions made for amount expected to be un realisable.

Hence, allowance method is preferable considering the point that in direct method, matching principle does not hold good, because the sales genarated and Bad debt accounted in two different years has deficiency in recognising the exact sales for each respective year

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