Under the direct write-off method, a bad debt is charged to expense as soon as it is apparent that an invoice will not be paid. Under the allowance method, an estimate of the future amount of bad debt is charged to a reserve account as soon as a sale is made. This results in the following differences between the two methods:
- Timing. Bad debt expense recognition is delayed under the direct write-off method, while the recognition is immediate under the allowance method. This results in higher initial profits under the direct write-off method.
- Accuracy. The exact amount of the bad debt expense is known under the direct write-off method since a specific invoice is being written off, while only an estimate is being charged off under the allowance method.
- Receivable line item. The receivable line item in the balance sheet tends to be lower under the allowance method, since a reserve is being netted against the receivable amount.