Which method is commonly used to account for bad debts?

The direct write-off method is commonly used to account for bad debts because it provides a straightforward approach to recognizing uncollectible accounts. Under this method, a company removes the uncollectible accounts receivable directly from accounts receivable and records a corresponding expense when it is determined that an account is no longer collectible. This method is simple and aligns with the cash basis of accounting, where income and expenses are recognized when cash is exchanged rather than when transactions occur.

This method is particularly advantageous for small businesses or entities with a limited number of accounts, as it simplifies the accounting process without requiring complex estimations. However, it is important to note that the direct write-off method should only be used when it is permissible under the financial reporting framework being followed, such as for tax purposes.

In contrast, the other methods have different focuses: the accrual method recognizes income and expenses when they are incurred, impacting the timing of when bad debts are recognized. The modified cash basis includes elements of both cash and accrual accounting but may not extensively address bad debts specifically. The percentage of sales method, while related to estimating bad debts, involves calculating an estimate based on sales, which can be more complex than simply recognizing actual bad debts as they occur.