The direct write-off method refers to the expensing of a receivable when the firm deems the receivable uncollectible.
The direct method involves two steps. First, the company has sufficient reason to believe that a past-due receivable will not be collected. Second, the company must make an accounting entry for the bad debt expense.
An important tool for recognizing bad debts is the accounts receivable (AR) aging report. The AR aging report breaks down the balance of the AR account into date ranges – usually the date ranges are set in 30-day increments. The date ranges allow the firm to identify those accounts which are past-due. The firm can then attempt to collect those accounts. After the company has made reasonable attempts to collect the past-due receivable, the company will likely identify the receivable as uncollectible and expense the debt.
For example, suppose a wholesaler has a $5,000 90-day past due receivable from one of its customers. The wholesaler has made reasonable attempts to collect the invoice. The wholesaler learns that the customer has gone out of business and will likely not pay the invoice. The wholesaler makes the following entry: debit bad debt expense by $5,000; credit accounts receivable by $5,000. This entry removes the receivable from the company’s books.
The direct write-off method is used for tax purposes but not for financial reporting purposes. Under U.S. GAAP, companies create a reserve account for future uncollectible receivables.
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