Question

What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?

Answer 1

The theoretical superiority of the allowance method over the direct write off method of accounting for bad debts is twofold. The revenue is measured to be predictable at the point of sale on the hypothesis that the resulting receivables are valid liquid assets merely pending collection, periodic income will be excessive to the extent of any receivables that eventually become uncollectible. The proper matching of revenue and expense requires that gross sales in the income statement be partly offset by a charge to bad debt expense that is established on an estimate of the receivables arising from gross sales that will not change into cash. Accounts receivable on the balance sheet should be specified at their estimated net realizable value. The allowance methods achieve this by deducting from gross receivables the allowance for doubtful accounts. The end is deriving from the charges for bad debt expense on the income statement.