Kristin is a Certified Public Accountant with 15 years of experience working with small business owners in all aspects of business building. In 2006, she obtained her MS in Accounting and Taxation and was diagnosed with Hodgkin’s Lymphoma two months later. Instead of focusing on the fear and anger, she started her accounting and consulting firm.

Understanding Post-Closing Trial Balances in Accounting

• By setting aside a reserve for potential bad debts, the allowance method aligns more closely with the accrual basis of accounting, matching expenses with the revenues they help generate.
• Account receivable and revenue will be recognized at the same time in the financial statements.
• Contrary to the treatment in the allowance method, we report the bad debt expense when it occurs in the direct write-off method.
• We must make sure to show that Joe Smith paid the amount he owed, not just the fact that the company received some cash.
• If the company underestimates the amount of bad debt, the allowance can have a debit balance.
• The allowance method is the standard technique for recording uncollectible accounts for financial accounting objectives and represents the accrual foundation of accounting.
• The direct write off method involves charging bad debts to expense only when individual invoices have been identified as uncollectible.

After analysing all of these factors, it is decided that just recording a transaction is not a condition of an accounting transaction. It must follow the norms and legislation established by the organisations for transaction accounting in order to present a true and accurate image of the financial statements to the entity’s stakeholders. An estimate shall be calculated each year and booked as an expensein order to avoid the wrong treatment of bad debt expense. Since sales are made on a credit basis there are chances of fraud and default payments which would result as an expense for the company at some point in the future. In the direct write off method example above, what happens if the client direct write-off method does end up paying later on?

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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. The direct write-off method waits until an amount is determined to be uncollectible before identifying it in the books as bad debt. Reporting revenue and expenses in different periods can make it difficult to pair sales and expenses and assets and net income can be overstated. The direct write-off method doesn’t adhere to the expense accounting matching principle—an expense must be recognized during the same period that the revenue is brought in.

Impact on Financial Statements

It also deals in actual losses instead of initial estimates, which can be less confusing. If Beth later receives the payment from the customer, she can reverse the write off journal entry by crediting bad debt and debiting accounts receivable. Beth can then record the receipt of the cash with a debit to cash and a credit to accounts receivable. The direct write-off method can influence a company’s financial statements, primarily through its impact on reported income and asset valuation.

It can lead to fluctuations in reported income, as bad debt expenses are recognized irregularly. This can make it challenging for stakeholders to assess a company’s financial performance accurately over time. Ariel would merely debit the bad debt expense account for $100 and credit the accounts receivable account for the equivalent amount using the direct write-off approach. This essentially cancels the receivable and reflects Ariel’s loss from the credit-worthy client.

Accounting Ratios

• This is called the matching principle, according to Accounting Tools.
• The allowance method offers an alternative to the direct write off method of accounting for bad debts.
• When using the percentage of sales method, the resulting amount is the amount of bad debt that should be recorded.
• Using the direct write-off method, Natalie would debit the bad debts expenses account by $ 1,500 and credit the accounts receivable account with the same amount.
• In the last 10 years, she has worked with clients all over the country and now sees her diagnosis as an opportunity that opened doors to a fulfilling life.
• It will report more revenue than might have actually been generated.

The adjusted balance in Allowance for Doubtful Accounts should be $31,800. Since the current balance is $17,000, we need to increase the balance to $31,800. The $14,800 is the amount of Law Firm Accounts Receivable Management Bad Debt Expense that must be recorded. After determining a debt to be uncollectible, businesses can use the direct write-off method to ensure records are accurate. In the direct write-off method example above, what happens if the client ends up paying later on?