Most businesses extend credit to other businesses as a way of increasing sales.

Question

Most businesses extend credit to other businesses as a way of increasing sales. The risk is that some of the accounts may not pay the amount due. In these cases, we have to account for uncollectible receivables. (1) Explain how the allowance method works (10 points) and (2) provide an example of a journal entry that would adjust accounts for the loss.

Explanation / Answer

Estimating bad debts as a percentage of sales is consistent with the matching concept in that the bad debt expense is recorded in the same time period as the associated revenue. Net credit sales x Bad debt percentage ---------------------- = Bad debt expense Note: When using the estimate based on sales, the entry for bad debt expense is made for the amount of the calculation. Examples: Jones Company has net credit sales of $75,000 and estimates that bad debts are approximately 3% of net credit sales. The year end balance in accounts receivable is $200,000. > Record the entry assuming that the allowance account currently has a credit balance of $300. The journal entry to record the bad debts would be as follows: Debit Credit ------- ------- Bad debt expense (75,000 x 3%) 2,250 Allowance for doubtful accounts 2,250 After the above entry, the allowance account would have a balance of $2,550 (i.e., $2,250 + $300). The net realizable value of accounts receivable after adjustment would be $197,450 (i.e., $200,000 - $2,550). > Record the entry assuming that the allowance account currently has a debit balance of $300. The journal entry to record the bad debts would be as follows: Debit Credit ------- ------- Bad debt expense (75,000 x 3%) 2,250 Allowance for doubtful accounts 2,250 A journal entry, in accounting, is a logging of transactions into accounting journal items. The journal entry can consist of several items, each of which is either a debit or a credit. The total of the debits must equal the total of the credits or the journal entry is said to be "unbalanced". Journal entries can record unique items or recurring items such as depreciation or bond amortization. In accounting software, journal entries are usually entered using a separate module from accounts payable, which typically has its own subledger that indirectly affects the general ledger; journal entries directly change the account balances on the general ledger. After the above entry, the allowance account would have a balance of $1,950 (i.e., $2,250 - 300). The net realizable value of accounts receivable after adjustment would be $198,050 (i.e., $200,000 - $1,950).

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