Using the direct write-off method means that no allowance is made, and that the company writes down accounts receivable once they are uncollectible. When an account receivable is written off, it is expensed:
bad debt expense x
accounts receivable x
There are two drawbacks of this method. First, applying the matching principle implies that the cost of the uncollectible accounts need to be expensed in the period of the sale. Giving credit to customers helps to generate sales (if this were not the case, the firm would simply demand payment at time of delivery).
Thus, not creating an allowance violates the matching principle. Second, accounts receivable are at the nominal value, whereas the ‘true’ value (the amount that is expected to be collectible) is probably lower. The next two methods overcome these drawbacks.
Direct Write Off Method Explained
– application of the matching principle implies that the expenses related to uncollectible accounts need to be booked in the period where the sales were made
– with the direct write-off method the expense is booked in the period when the account is uncollectible, which is not in accordance with the matching principle