Q11RQ - Horngren'S Financial And Managerial Accounting

Question

What are some limitations of using the direct write-off method?

Step-by-Step Solution

Answer

Answer

1. It is against the matching principle.

2. Over-estimation of the receivables. 

Step 1: Definition of the Accounts Receivables

The accounts receivables report the sales amount for which payment is still due from the customer. It is considered a current asset of the business as the entity expects to receive it within one year.

Step 2: Limitations of the direct write-off method

1. The direct-write-off method does not comply with the matching principle and is also not accepted under GAAP. The matching principle states that expenses must be recorded when revenue is earned, but under the direct write-off, method expenses are recorded in the future months. 

2. Under the direct write-off method, receivables are overstated on the balance sheet because the estimated bad debts are not adjusted against the accounts receivables.