Before You Start

This guide assumes a solid understanding of Accounts Receivable (AR) and Generally Accepted Accounting Principles (GAAP). It’s tailored for CFOs, controllers, and advanced bookkeepers.

Overview

20 min
Review Time
Advanced
Difficulty
Quarterly
Maintenance

What You’ll Learn

  • GAAP methods for recording customer discounts
  • Implementing the Allowance Method for bad debt
  • When and how to use the Direct Write-Off Method
  • Creating accurate journal entries for AR adjustments

1. Essential Accounts & Policies

Ensure your chart of accounts includes these, and have a clear policy for each:

Required Accounts

  • Sales Discounts (Contra-Revenue)
  • Bad Debt Expense (Expense)
  • Allowance for Doubtful Accounts (Contra-Asset)
  • Accounts Receivable (Asset)

Key Policies Needed

  • Credit Policy & Terms (e.g., 2/10, net 30)
  • Bad Debt Estimation Method (e.g., percentage of sales, aging of receivables)
  • Approval Limits for Write-Offs

2. Discount & Write-Off Methods

You have specific methods for handling these, each with GAAP implications.

Customer Discounts: Gross vs. Net Method

This determines how you record potential discounts.

Gross Method (Simpler):
  • Assumes customers won’t take discount.
  • Adjusts revenue only if discount is taken.
  • Less complex initial recording.
Net Method (GAAP Preferred):
  • Assumes customers will take discount.
  • Records AR at net amount.
  • Requires adjustment if discount is not taken.

Bad Debt: Allowance vs. Direct Write-Off

The choice impacts financial statement accuracy.

GAAP Preference: The Allowance Method is the preferred GAAP method for companies with material accounts receivable, as it matches bad debt expense with related revenues in the same period. The Direct Write-Off method violates the matching principle.

3. Step-by-Step: Recording Discounts & Bad Debt

Here are typical journal entries for common scenarios.

Here is a sample entry for a customer discount taken (Gross Method).

{
  "date": "2025-01-15",
  "description": "Customer paid within discount period",
  "entries": [
    { "account": "Cash", "debit": 980.00 },
    { "account": "Sales Discounts", "debit": 20.00 },
    { "account": "Accounts Receivable", "credit": 1000.00 }
  ]
}

4. Implementing the Allowance Method

  1. 1

    Estimate Bad Debt

    At period-end, estimate uncollectible AR using a percentage of sales or an aging schedule. Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts.

  2. 2

    Write Off Specific Accounts

    When a specific account is deemed uncollectible, Debit Allowance for Doubtful Accounts, Credit Accounts Receivable. This has no impact on Bad Debt Expense.

  3. 3

    Recover Previously Written-Off Accounts

    If a written-off account is later collected, reverse the write-off (Debit AR, Credit Allowance) then record the cash collection (Debit Cash, Credit AR).

Common Error: Double-Counting Expense

When using the Allowance Method, remember that the initial estimation entry creates the expense. Writing off a specific receivable reduces the Allowance account, not Bad Debt Expense directly. Avoid debiting Bad Debt Expense again during a write-off.

5. Using the Direct Write-Off Method

Direct Write-Off Checklist

  • Only for immaterial amounts or when collectibility is certain to be zero
  • Violates GAAP’s matching principle; use for tax purposes only sometimes
  • Debit Bad Debt Expense, Credit Accounts Receivable directly
  • No Allowance account is used with this method

Need Help?

Expert Accounting Guidance

Navigating complex accounting standards can be challenging. Our team offers specialized support for your financial reporting needs.

Contact Our Experts