What are the two primary methods for accounting for bad debts, and what are the basic effects?

• A. The allowance method (estimate and record an allowance).
• B. Capitalizes the loss as an asset.
• C. Direct write-off (recognize bad debt expense when unrecoverable; debit Bad Debt Expense, credit Accounts Receivable).
• D. Record bad debts as a reduction of sales.

Answer: (C)

Two main ways to handle uncollectible accounts are the direct write-off method and the allowance method. The option described here matches the direct write-off approach: you recognize a bad debt expense only when a specific receivable is determined to be uncollectible, and you debit Bad Debt Expense while crediting Accounts Receivable. The basic effect is that when you write off a specific customer, your assets (accounts receivable) drop by that amount and your expenses rise by the same amount, reducing net income in that period. No separate contra-asset account is used, and there is no prior estimate of uncollectibles.

The other widely used method—the allowance method—works differently. Here you estimate future uncollectibles and record an Allowance for Doubtful Accounts (a contra-asset) in advance, matching part of the bad debt expense to the period in which the related sales occur. This approach reduces the net realizable value of receivables on the balance sheet and typically spreads the expense over the period of sale rather than waiting for a specific write-off.

The other choices describe incorrect or incomplete treatments: capitalizing the loss as an asset isn’t how bad debts are recorded, and reducing sales isn’t the proper way to reflect uncollectibles. The allowance method is the complementary primary method to direct write-off, and both describe the fundamental ways companies account for bad debts.