Question

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

Short answer

The allowance method for bad debt is theoretically justified because it complies with the matching principle andreports receivables on their net realizable value.

Step-by-step solution

Definition of Matching Principle

The matching principle of accounting states that a business entity must report expenses in the same period in which the revenues related to these expenses are reported.

Theoretical Justification

1. The first reason allowance method proves to be theoretically justified is that it reports bad debt expenses when credit sales are made by the business entity and therefore does not overstate the income of the business entity.

2. The second reason the allowance method proves to be theoretically justified is that it reports the accounts receivables after deducting an allowance for bad debts representing its net realizable value.