Direct write off method definition

A write-off is an extreme version of a write-down, where the book value of an asset is reduced below its fair market value. For example, damaged equipment may be written down to a lower value if it is still partially usable, and debt may be written down if the borrower is only able to repay a portion of the loan value. Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting. The content of this article is meant to be used as general information and help.

The estimated amount is debited from the Bad Debts Expense and credited to an Allowance for Doubtful Accounts to maintain balance. The direct write-off method can be a useful option for small businesses infrequently dealing with bad debt or if the uncollectibles are for a small amount. After determining a debt to be uncollectible, businesses can use the direct write-off method to ensure records are accurate. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

Direct Write-Off Method vs. Allowance Method

The Internal Revenue Service allows individuals to claim a standard deduction on their income tax returns. Individuals can also itemize deductions if they exceed the standard deduction level. Financial institutions use write-off accounts when they have exhausted all methods of collection action. Write-offs may be tracked closely with an institution’s loan loss reserves, which is another type of non-cash account that manages expectations for losses on unpaid debts. Loan loss reserves work as a projection for unpaid debts, while write-offs are a final action.

Under this method, a company at the end of its business year needs to review its accounts receivable and estimate how much of the total figure it thinks it won’t be able to collect. Under the direct write-off method, a bad debt is charged to expense as soon as it is apparent that an invoice will not be paid. This is the simplest way to recognize a bad debt, since the entry is only made when a specific customer invoice has been identified as a bad debt. The business is left out of pocket with “bad debt” to balance in the books. The direct write off method offers a way to deal with this for accounting purposes, but it comes with some pros and cons.

Balance Sheet

Bad debt refers to debt that customers owe for a good or service but won’t be paying back. In other words, it’s money they need to pay for a sale or service that they won’t be paying and the company won’t be receiving. Using the direct write-off method can help your business easily manage bad debt if you rarely get uncollected payments. In this article, you’ll learn how to use the direct write-off method for your business and the potential advantages and disadvantages of a direct write-off.

Hence, the sales amount remains intact, account receivables are eliminated and the bad debt expense account increases. This implies that the loss is being stacked up on the income statement against the revenue that is unrelated to the project when it is represented as an expense. Total revenue is now incorrect in both the period in which the invoice was recorded and the period in which the bad debt was expensed. The allowance approach, similar to putting money in a reserve account, anticipates uncollectible accounts.