Contrary to allowance method of recording bad debts, direct write-off method does not require estimation of credit losses. When a customer defaults and it is certain that a receivable will not be collected, that receivable is directly written off in the books of account.
Following journal entry is made to record the bad debts.
Bad debts expense (P/L) – Debit
Accounts receivable – Credit
Let’s take a look at the following example to understand the accounting of bad debts under direct write-off method.
Example – Direct write-off method of recording bad debts
On 31 January, Fast Courier Co. has accounts receivable balance of $50,000. Credit revenue during the month was $60,000 whereas $10,000 was collected from customers. At the time of monthly reporting, it is estimated that $5,000 is not likely to be recovered.
On 15th February, a customer having a balance due of $3,000 defaults and confirms that he will not be able to pay the amount due. In February, Fast Courier Co. earns credit revenue of $60,000 and collects $30,000 cash from its debtors.
Following journal entries will be made to record the bad debt expense.
In the financial statements for the month of January,
- Net balance of $50,000 will be presented as accounts receivable on the balance sheet.
- No bad debts expense will be reported in the income statement.
In the financial statements for the month of February,
- Net balance of $77,000 will be presented as accounts receivable on the balance sheet.
- Bad debts expense of $3,000 will be reported in the income statement.