Write-off methods - overview
In this topic, you will read about how write-off methods are used and what transactions are generated when you implement the direct write-off or allowance method.
Direct write-off method
Your business may use the direct write-off method for financial reporting when you can determine that an amount will be uncollectible in the period when the sale took place and that the amount represents an insignificant amount, as with bank charges. The direct write-off method ignores VAT amounts previously paid to a tax authority on the documents being written off. You may need to manually record the written-off amounts and the corresponding VAT amounts to use them for adjustments to the tax return.
In the direct method, a write-off requires a journal entry that increases an expense account (the Balance write-off account) and a journal entry that decreases accounts receivable for the customer. You configure a reason code that determines the expense account and then write off an amount from a customer invoice by using this reason code. Accounts are affected as shown below.
| Account | Debit | Credit |
|---|---|---|
| Balance write-off account | Amount | 0.0 |
| Customer ledger account | 0.0 | Amount |
If you write off customer credits, the amount will be recognised as income, and the customer balance of accounts receivable will be increased. You configure a reason code that determines the income account and then write off an amount from a customer invoice by using this reason code. Accounts are affected as shown in the following table.
| Account | Debit | Credit |
|---|---|---|
| Credit write-off account | 0.0 | Amount |
| Customer ledger account | Amount | 0.0 |
If a customer pays a debt that has been written off, you enter the payment as usual and do not apply it to any document. You then write off the payment by using a document of the Credit write-off type.
Allowance method
The allowance method is based on the idea that some of customer debts will not be paid, although companies don’t know in advance which customers will not pay. This method involves using two special accounts:
- Allowance for doubtful accounts: This contra asset account to accounts receivable contains the estimated amount of the debts that will not be collected. The estimate may be a percentage of sales or an amount based on an ageing analysis of sales receivables.
- Bad debts expense: This is a temporary expense account that reports credit losses for only the period shown on the income statement.
The allowance method is used as follows: At the end of the accounting period, you estimate the amount to become uncollectible in accounts receivable and manually update accounts by using the Journal transactions (GL301000) window.
Accounts are affected as shown below.
| Account | Debit | Credit |
|---|---|---|
| Bad debts expense | Amount | 0.0 |
| Allowance for doubtful accounts | 0.0 | Amount |
You configure a reason code that points to the Allowance for doubtful accounts account. When a specific customer’s account is identified as uncollectible, you write off debts by using this reason code. Accounts are affected as shown below.
| Account | Debit | Credit |
|---|---|---|
| Allowance for doubtful accounts | Amount | 0.0 |
| Customer ledger account (customer account) | 0.0 | Amount |
Under the allowance method, a write-off does not change the net realisable value of sales receivables. It simply reduces sales receivables and the allowance for bad debts by equivalent amounts.
Related pages
Concepts
- About write-off setup
- Manage credit policy - overview
- About payment terms
- About credit verification
- About customer credit hold
- About overdue charges
- Statement cycles - overview