Dr. Cr. Accounts receivable $150,000 Allowance for doubtful accounts $ 2,500 Sal

Question

                                                                                        Dr.                   Cr.   

Accounts receivable                                                $150,000

Allowance for doubtful accounts                                                     $    2,500

Sales (all on credit)                                                                            850,000

Sales returns and allowances                                      40,000

Instructions

(a)   Prepare the entries for estimated bad debts assuming that doubtful accounts are estimated to be (1) 6% of gross accounts receivable and (2) 1% of net sales.

(b)   Assume that all the information above is the same, except that the Allowance for Doubtful Accounts has a debit balance of $2,500 instead of a credit balance. How will this difference affect the journal entries in part (a)?

(c)   What is the theoretical justification for each of the two allowance methods used to estimate bad debts?

Explanation / Answer

(a) (1) Doubtful accounts are estimated to be 6% of gross accounts receivable:

-Gross Accounts Receivable: $ 150,000 D

-Doubtful Accounts: 6% of Gross Accounts Receivable or 6% of $150,000 = $9,000

-Allowances for Bad Debts already created: $ 2,500 C

-Additional Allowances to be created: $6,500 ($9,000 - $2,500)

Entry:

Bad Debts a/c (Expense) Dr. $ 6,500

To Allowance for doubtful accounts a/c (Provision) Cr. $ 6,500.

(a) (2) Doubtful accounts are estimated to be 1% of net sales.

-Net Sales: $ 810,000 ($850,000 - $40,000)

-Doubtful Accounts: 1% of Net Sales or 1% of $ 810,000 = $ 8,100.

-Allowances for Bad Debts already created: $ 2,500 C

-Additional Allowances to be created: $8,100

Entry:

Bad Debts a/c (Expense) Dr. $ 8,100

To Allowance for doubtful accounts a/c (Provision) Cr. $ 8,100.

(b) Allowance for Doubtful Accounts has a debit balance of $ 2,500 instead of a credit balance.

Entry for (a) (1)

-Allowances for Bad Debts already created: $ 2,500 D

-Additional Allowances to be created: $11,500 ($9,000 + $2,500)

Entry

Bad Debts a/c (Expense) Dr. $ 11,500

To Allowance for doubtful accounts a/c (Provision) Cr. $ 11,500.

Revised Entry for (a) (2)

-Allowances for Bad Debts already created: $ 2,500 D

-Additional Allowances to be created: $ 8,100 C

Entry

Bad Debts a/c (Expense) Dr. $ 8,100

To Allowance for doubtful accounts a/c (Provision) Cr. $ 8,100.

(c) Justification for Methods:

Both the above methods are allowed to be used by entities in providing for Doubtful debts during the period and are accepted by GAAP worldwide. The basic concept being providing for losses when the entity doubts the recovery of any receivables in future. Hence in future when the actual Bad Debts occur, the entity would simply reduce the balance of Debtors/Accounts receivables by Crediting The A/c Receivable Ledger, and Debiting Allowance for doubtful accounts a/c.

Now the method of providing for Doubtful Accounts with respect to the Accounts Receivable balances, takes into account the outstanding Balance as on any particular date, and the Allowance for doubtful account Ledger is adjusted subsequently to bring it in level with the Percentage of Doubtful receivables on Closing Balance of Account Receivables, as done in 1(a) above. Hence the amount if Expense in this method, does not always be equal to the amount of Provision Required.

Second method provides for Doubtful Receivables on the basis of Credit Sales during the Period, such provision is simply added to the Opening Balance of Allowance for doubtful accounts a/c.

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.