Why does gaap favor the allowance method

In addition, companies record allowances for bad debts, sales returns, inventory obsolescence and asset impairment under GAAP. GAAP has become increasingly complex in recent years. But GAAP statements typically work better if the company has unsecured debt or numerous shareholders who own minority interests.

Likewise, prospective buyers may prefer to perform due diligence on GAAP financial statements — or they may be public companies that are required to follow GAAP. Tax-basis reporting makes sense for certain types of businesses. But for other businesses, tax-basis financial statements may result in missing or even misleading information.

We can help you evaluate the pros and cons and choose the appropriate reporting framework for your situation. Toggle navigation GAAP vs. Privacy Policy. Skip to main content. Unit Receivables. Search for:. Direct Write-Off and Allowance Methods Because customers do not always keep their promises to pay, companies must provide for these uncollectible accounts in their records.

Direct Write-off The direct write-off method is used only when we decide a customer will not pay. When we write-off an account under this method, the entry would be: Debit Credit Bad Debt Expense X Accounts Receivable X The amount used will be the amount the customer owes that we will not be able to collect. Allowance Method The allowance method follows GAAP matching principle since we estimate uncollectible accounts at the end of the year. When we write-off a customer account under the allowance method, the entry would be: Debit Credit Allowance for Doubtful Accounts X Accounts Receivable X Notice how we do not use bad debts expense in a write-off under the allowance method.

As of December 31, ? What factors does Coca-Cola use to determine the amount of its allowance for doubtful accounts? In this way, you book the revenue and the matching expense in the same period. When it becomes clear that a customer is not going to fork over the cash, you must write off the receivable -- it's a bad debt.

Rather, you reduce allowance for doubtful accounts with a debit for the write-off and credit accounts receivable by the same amount. Thus, the income statement is unaffected by the write-off. At the end of year one, you calculate the ratio of bad debts to sales over the previous three years and find that 2 percent of credit sales ended up as bad debts.

GAAP makes no recommendation about hiring a collection agency. He holds an M.