Communication Case 7-1
ACCT301-D04
Darlene Mix
Professor Lauffer
November 25, 2021
You have been hired as a consultant by a parts manufacturing firm to provide advice as to
the proper accounting methods the company should use in some key areas. In the area of
receivables, the company president does not understand your recommendation to use the
allowance method for uncollectible accounts. She stated, “Financial statements should be based
on objective data rather than the guesswork required for the allowance method. Besides, since
my uncollectibles are fairly constant from period to period, with significant variations occurring
infrequently, the direct write-off method is just as good as the allowance method.”
In order to explain why the manufacturing firm should use the allowance method for
uncollectible accounts, the president must understand difference between the allowance method
and the direct write-off method. When the company sells the parts that they make, they are
entitled to be paid for those parts, but there are sometimes situations where this does not happen.
In this case, the company will have to have in place a way to recognize those non-payments, or
bad debts.
According to the textbook, Intermediate Accounting, the direct write-off method of
accounting for bad debts is to wait until the decision is made that the account cannot be collected
and to write it off as a bad debt at that time [CITATION Spi20 \p 350 \l 1033 ]. When accounting
is done in accordance with Generally Accepted Accounting Principles (GAAP), the direct write-
off method is not allowed. There are some problems which are created when using this method.
Using this method may overstating the balance in accounts receivable in any periods before
writing off the debt because it is hard to determine whether some accounts would not be paid.
The other issue comes from knowing that an account will be unable to be paid, but the firm does
not recognize the bad debt at that time and recognizes the bad debt at a later period [ CITATION
Spi20 \l 1033 ].
On the other hand the allowance method of recognizing bad debts on accounts receivable
is required when following the rules of GAAP. The main difference in the allowance method is
that a bad debt is recognized when the company estimates that the account will not be collect and
the allowance for that account is created [ CITATION Spi20 \l 1033 ]. Using the allowance
method of recognizing bad debts shows a more realistic picture of income for different time
periods.
The FASAB has specific rules pertaining to uncollectible amounts, which are illustrated
below. This rule is under SFFAS No. 1. Accounting for Selected Assets and Liabilities page 43 of
SFFAS 7, paragraph 126 and is written as:
“When realization of the full amount of recognized revenue is not probable, the
standards require that a separate provision be made if the uncollectible amount can be
reasonably estimated. The Board defines “probable” as “more likely than not.” This
definition, and measurability, are the criteria for recognizing losses due to uncollectible
amounts of accounts receivable under Federal accounting standards [ CITATION
FAS21 \l 1033 ].”
In order to explain to the company president that it is important to use the allowance
method of accounting for bad debts, I would show that not only is the allowance method required
under GAAP accounting, it also illustrates a more realistic picture of actual income for a period.
Using the direct write-off method will misrepresent actual income or losses from bad debt for
that period. It is important to be honest in all reporting the financial stability of a business by
recognizing income or losses in the correct period. I would also explain that even though she said
there is not really any change in variations for bad debts, the economy and business operations
change daily and could affect the company’s financial projections for the future.
REFERENCES
FASAB handbook of federal accounting standards and other pronouncements, as amended.
(2021, June 30). https://files.fasab.gov/pdffiles/2021_%20FASAB_%20Handbook.pdf
Spiceland, J. D. (2020). Intermediate Accounting 10th Edition. New York, New York, US:
McGraw-Hill Education. https://prod.reader-
ui.prod.mheducation.com/epub/sn_0f85/data-uuid-5a90c3ed089343b9bdda2498f0689f67
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