Chapter 16, Problem 5SEA

UNCOLLECTIBLE ACCOUNTS—PERCENTAGE OF SALES AND PERCENTAGE OF RECEIVABLES At the end of the current year, the accounts receivable account of Glenn’s Nursery Supplies has a debit balance of $390,000. Credit sales are $2,800,000. Record the end-of-period adjusting entry on December 31, in general journal form, for the estimated uncollectible accounts. Assume the following independent conditions existed prior to the adjustment:

1. 1. Allowance for Doubtful Accounts has a credit balance of $1,760.
   1. (a) The percentage of sales method is used and bad debt expense is estimated to be 1% of credit sales.
   2. (b) The percentage of receivables method is used and an analysis of the accounts produces an estimate of $30,330 in uncollectible accounts.
2. 2. Allowance for Doubtful Accounts has a debit balance of $1,900.
   1. (a) The percentage of sales method is used and bad debt expense is estimated to be ¾ of 1% of credit sales.
   2. (b) The percentage of receivables method is used and an analysis of the accounts produces an estimate of $29,890 in uncollectible accounts.

To determine

Record the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of sales method).

Explanation of Solution

Bad debt expense:

Bad debt expense is an expense account. The amounts of loss incurred from extending credit to the customers are recorded as bad debt expense. In other words, the estimated uncollectible accounts receivable are known as bad debt expense.

Allowance method:

It is a method for accounting bad debt expense, where uncollectible accounts receivables are estimated and recorded at the end of particular period. Under this method, bad debts expenses are estimated and recorded prior to the occurrence of actual bad debt, in compliance with matching principle by using the allowance for doubtful account.

Two methods to estimate uncollectible accounts under allowance method are:

1. 1. Percentage of sales method, and
2. 2. Analysis of receivables method.

According to accrual basis method of accounting, the allowance method is mostly required for financial reporting purposes.

Percentage of sales method:

Credit sales are recorded by debiting (increasing) accounts receivable account. The bad debts is a loss incurred out of credit sales, hence uncollectible accounts can be estimated as a percentage of credit sales or total sales.

It is a method of estimating the bad debts (expected loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of net credit sale (or total sales) for a specific period. Under percentage of sales method, estimated bad debts would be treated as a bad debt expense of the particular period.

Percentage-of-receivables basis:

It is a method of estimating the bad debts (loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of receivables for a specific period. Under this method, the estimated bad debts would be treated as a target allowance balance.

Record the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of sales method):

Date	Particulars	Debit	Credit
December 31	Bad debt expense	$28,000
	Allowance for doubtful accounts		$28,000
	(To adjust the allowance for doubtful accounts)

Table (1)

Working note 1:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Credit sales amount}\times \\ \text{Estimated credit sales percentage}\end{array}\right]\\ =\left[\$2,800,000\times 1\%\right]\\ =\$28,000\end{array}$

Description:

• Bad debt expense is an expense account. Since expenses and losses decrease the stockholders’ equity account. Therefore, bad debt expense account is debited.
• An increase in allowance for doubtful accounts (contra asset account) will decrease the asset account. Therefore, allowance for doubtful accounts is credited.

To determine

Record the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of receivables method).

Explanation of Solution

Percentage-of-receivables basis:

It is a method of estimating the bad debts (loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of receivables for a specific period. Under this method, the estimated bad debts would be treated as a target allowance balance.

Record the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of receivables method):

Date	Particulars	Debit	Credit
December 31	Bad debt expense	$28,570
	Allowance for doubtful accounts		$28,570
	(To adjust the allowance for doubtful accounts)

Table (2)

Working note 2:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Total estimated uncollectibles under}\\ \text{the percentage-of-receivables basis}-\text{Credit}\\ \text{balance in allowance for doubtful accounts}\end{array}\right]\\ =\left[\$30,330-\$1,760\right]\\ =\$28,570\end{array}$

Description:

• Bad debt expense is an expense account. Since expenses and losses decrease the stockholders’ equity account. Therefore, bad debt expense account is debited.
• An increase in allowance for doubtful accounts (contra asset account) will decrease the asset account. Therefore, allowance for doubtful accounts is credited.

To determine

Record the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of sales method).

Explanation of Solution

Percentage of sales method:

Credit sales are recorded by debiting (increasing) accounts receivable account. The bad debts is a loss incurred out of credit sales, hence uncollectible accounts can be estimated as a percentage of credit sales or total sales.

It is a method of estimating the bad debts (expected loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of net credit sale (or total sales) for a specific period. Under percentage of sales method, estimated bad debts would be treated as a bad debt expense of the particular period.

Record the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of sales method):

Date	Particulars	Debit	Credit
December 31	Bad debt expense	$21,000
	Allowance for doubtful accounts		$21,000
	(To adjust the allowance for doubtful accounts)

Table (3)

Working note 3:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Credit sales amount}\times \\ \text{Estimated credit sales percentage}\end{array}\right]\\ =\left[\$2,800,000\times \frac{\text{3}}{4}\text{ of }1\%\text{credit sales}\right]\\ \text{=\$21,000}\end{array}$

Description:

• Bad debt expense is an expense account. Since expenses and losses decrease the stockholders’ equity account. Therefore, bad debt expense account is debited.
• An increase in allowance for doubtful accounts (contra asset account) will decrease the asset account. Therefore, allowance for doubtful accounts is credited.

To determine

Record the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of receivables method).

Explanation of Solution

Percentage-of-receivables basis:

It is a method of estimating the bad debts (loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of receivables for a specific period. Under this method, the estimated bad debts would be treated as a target allowance balance.

Record the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of receivables method):

Date	Particulars	Debit	Credit
December 31	Bad debt expense	$31,790
	Allowance for doubtful accounts		$31,790
	(To adjust the allowance for doubtful accounts)

Table (4)

Working note 4:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Total estimated uncollectibles under}\\ \text{the percentage-of-receivables basis + Debit}\\ \text{balance in allowance for doubtful accounts}\end{array}\right]\\ =\left[\$29,890+\$1,900\right]\\ =\$31,790\end{array}$

Description:

• Bad debt expense is an expense account. Since expenses and losses decrease the stockholders’ equity account. Therefore, bad debt expense account is debited.
• An increase in allowance for doubtful accounts (contra asset account) will decrease the asset account. Therefore, allowance for doubtful accounts is credited.