Question

Simms Company has significant amounts of trade accounts receivable. Simms uses the allowance method to estimate bad debts instead of the direct write-off method. During the year, some specific accounts were written off as uncollectible, and some that were previously written off as uncollectible were collected.

Instructions

(a) What are the deficiencies of the direct write-off method?

(b) Briefly describe the allowance method to estimate bad debts and the theoretical justification for its use?

(c) How should Simms account for the collection of the specific accounts previously written off as uncollectible?

Short answer

1. Matching principle of accounting is not followed under the direct write-off method.
2. Net realizable value of accounts receivable is calculated under the allowance method.
3. One entry for the re-statement of accounts receivables and one entry for cash collection.

Step-by-step solution

Definition of Net Realizable Value

The value representing the amount of money that can be generated through the sale of the current asset is known as net realizable value.

Deficiencies of direct-write off method

Under the direct write-off method, the accounts receivables are not reported on their net realizable value. It also does not write off bad debts in the same period of revenue generation and therefore does not comply with the matching principle.

Justification of allowance method

The allowance method is theoretically justified because it reports the accounts receivables on their net realizable value. Under the allowance method, the bad debts are estimated as a percentage of the balance of accounts receivables.

Reporting recovery of bad debts

Two journal entries will be made:

Date	Accounts and Explanation	Debit $	Credit $
1	Accounts receivables	xxx
	Allowance for doubtful accounts		xxx
2	Cash	xxx
	Accounts receivables		xxx