Two methods of accounting for uncollectible accounts are the

a. cost method.
b. Interest method.
c. equity method.
d. direct write-off method.

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The Correct Answer for the given question is option d. direct write-off method.

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Answer Explanation for Question: Two methods of accounting for uncollectible accounts are the

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Direct Write-Off Method

The direct write off method involves charging uncollectable invoices to expense only when specific invoices have been identified as uncollectible. It is possible to consider this type of accounting method reasonable if the amount to be written off is an immaterial amount, since doing so has minimal impact on an entity’s reported financial results, and so would not skew the decisions of someone viewing the financial statements of the company.

The Internal Revenue Service requires use of this method for the reporting of taxable income in the United States since it believes (perhaps correctly) that companies might otherwise be tempted to inflate their bad debt reserves in order to report a smaller amount of taxable income.

The Direct Write-Off Method of Accounting

Under this method, the account receivable is written off by creating a credit memo for the customer in question, which equals the amount of the bad debt. A credit memo debits an account for bad debt expenses and a credit account for accounts receivable. In this method, there is no reduction in the amount of recorded sales, only an increase in bad debt expense.

For instance, a business records a sale on credit of Rs. 10,000 by debiting the accounts receivable account and crediting the sales account. As a result, the seller has to write off Rs.2,000 to the accounts receivable account and offset the debit to the bad debt expense account. The seller can only collect $8,000 of the open balance after two months, so the seller must write off the balance over two months.

This results in the revenue amount remaining the same, the remaining receivable being eliminated, and a bad debt expense being created.

Limitations of the Direct Write- Off Method

Direct write-offs violate the matching principle, which stipulates that all costs associated with revenue are applied to expenses in the same period in which revenue is recognized, so the financial results of an entity encompass the full extent of a revenue-generating transaction at the end of the year.
Direct write offs delay the recognition of some expenses associated with a revenue-generating transaction, so it is considered an excessively aggressive accounting method, since it delays some expense recognition, making a reporting entity appear more profitable in the short term than it actually is.
If a company sells $1 million in sales, it may wait three or four months to collect all the related accounts receivables, and then charge off some bad debts as an expense. It results in a long delay between revenue recognition and the recognition of expenses relating to that revenue. As a result, the profit in the first month is overstated, whereas the profit in the month when the bad debts are finally charged to expenses is understated.

Lastly,

I hope after going through this post you might have clearly understood the Question: Two methods of accounting for uncollectible accounts are the direct write-off method.

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I hold a MBA degree from Presidential Business School, Kathmandu, and a BBA degree with a specialization in Finance from Apex College,

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