Final answer:
The direct write-off method records bad debts by directly reducing the accounts receivable balance when a debt is deemed uncollectible. This method can violate the matching principle and may allow for the manipulation of earnings due to timing discretion.
Step-by-step explanation:
Under the direct write-off method, bad debts are accounted for by directly writing off specific accounts receivable that are deemed uncollectible. This is done by recording a bad debts expense in the income statement at the point when the debt is considered irrecoverable. The entry typically involves a debit to the bad debts expense account and a credit to the accounts receivable account, which directly reduces the receivables balance on the balance sheet.
One major disadvantage of this method is that it often violates the matching principle of accounting, because the bad debt expense may be recognized in a different period than the revenue it relates to. This can make financial statements less accurate in terms of reporting the actual profitability in a given period. Additionally, the method can also be manipulated to influence earnings, as it provides a discretion to the company on when to write off debts, which can affect the timing of expense recognition.