Chapter 16, Problem 9SPA

UNCOLLECTIBLE ACCOUNTS—PERCENTAGE OF SALES AND PERCENTAGE OF RECEIVABLES At the completion of the current fiscal year ending December 31, the balance of Accounts Receivable for Yang’s Gift Shop was $30,000. Credit sales for the year were $355,200.

REQUIRED

Make the necessary adjusting entry in general journal form under each of the following assumptions. Show calculations for the amount of each adjustment and the resulting net realizable value.

1. 1. Allowance for Doubtful Accounts has a credit balance of $330.
   1. (a) The percentage of sales method is used and bad debt expense is estimated to be 2% of credit sales.
   2. (b) The percentage of receivables method is used and an analysis of the accounts produces an estimate of $6,950 in uncollectible accounts.
2. 2. Allowance for Doubtful Accounts has a debit balance of $400.
   1. (a) The percentage of sales method is used and bad debt expense is estimated to be 1.5% of credit sales.
   2. (b) The percentage of receivables method is used and an analysis of the accounts produces an estimate of $5,685 in uncollectible accounts.

To determine

Prepare the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of sales method) and calculate the amount of net realizable value.

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.

Prepare 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	$7,104
	Allowance for doubtful accounts		$7,104
	(To adjust the allowance for doubtful accounts)

Table (1)

Working note 1:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Credit sales amount}\times \\ \text{Estimated credit sales percentage}\end{array}\right]\\ =\left[\$355,200\times 2\%\right]\\ =\$7,104\end{array}$

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.

Net realizable value: Net realizable value is the net amount of receivables which a business expects to collect from its debtors. Accounts receivable less allowance for doubtful accounts is represented as cash realizable value.

Formula to calculate the net realizable value:

$\text{Net realizable value}=\text{Accounts receivable-Allowance for doubtful accounts}$

Calculate the net realizable value of the accounts receivable:

$\begin{array}{c}\text{Net realizable value}=\left(\begin{array}{l}\text{Accounts receivable}-\\ \text{Allowance for doubtful accounts}\end{array}\right)\\ =\left(\text{\$30,000}-\$7,434\right)\\ =\$22,566\end{array}$

Working note 2:

Calculate the amount of allowance for doubtful accounts.

$\begin{array}{c}\text{Allowance for doubtful accounts =}\left(\begin{array}{l}\text{ Bad debt expense amount + }\\ \text{Credit balance of allowance for doubtful accounts }\end{array}\right)\\ =\left(\$7,104+\$330\right)\\ =\$7,434\end{array}$

To determine

Prepare the adjusting entry on December 31 for allowance for doubtful accounts having a credit balance (using percentage of receivables method) and calculate the amount of net realizable value.

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.

Prepare 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	$6,620
	Allowance for doubtful accounts		$6,620
	(To adjust the allowance for doubtful accounts)

Table (2)

Working note 3:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Total estimated uncollectibles under}\\ \text{the percentage-of-receivables basis}-\text{Credit}\\ \text{balance in allowance for doubtful accounts}\end{array}\right]\\ =\left[\$6,950-\$330\right]\\ =\$6,620\end{array}$

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.

Calculate the net realizable value of the accounts receivable:

$\begin{array}{c}\text{Net realizable value}=\left(\begin{array}{l}\text{Accounts receivable}-\\ \text{Allowance for doubtful accounts}\end{array}\right)\\ =\left(\text{\$30,000}-\$6,950\right)\\ =\$23,050\end{array}$

Working note 4:

Calculate the amount of allowance for doubtful accounts.

$\begin{array}{c}\text{Allowance for doubtful accounts =}\left(\begin{array}{l}\text{ Bad debt expense amount + }\\ \text{Credit balance of allowance for doubtful accounts }\end{array}\right)\\ =\left(\$6,620+\$330\right)\\ =\$6,950\end{array}$

To determine

Prepare the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of sales method) and calculate the amount of net realizable value.

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.

Prepare 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	$5,328
	Allowance for doubtful accounts		$5,328
	(To adjust the allowance for doubtful accounts)

Table (3)

Working note 5:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Credit sales amount}\times \\ \text{Estimated credit sales percentage}\end{array}\right]\\ =\left[\$355,200\times 1.5\%\right]\\ =\$5,328\end{array}$

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.

Net realizable value: Net realizable value is the net amount of receivables which a business expects to collect from its debtors. Accounts receivable less allowance for doubtful accounts is represented as cash realizable value.

Formula to calculate the net realizable value:

$\text{Net realizable value}=\text{Accounts receivable-Allowance for doubtful accounts}$

Calculate the net realizable value of the accounts receivable:

$\begin{array}{c}\text{Net realizable value}=\left(\begin{array}{l}\text{Accounts receivable}-\\ \text{Allowance for doubtful accounts}\end{array}\right)\\ =\left(\text{\$30,000}-\$4,928\right)\\ =\$25,072\end{array}$

Working note 6:

Calculate the amount of allowance for doubtful accounts.

$\begin{array}{c}\text{Allowance for doubtful accounts =}\left(\begin{array}{l}\text{ Bad debt expense amount }-\\ \text{Debit balance of allowance for doubtful accounts }\end{array}\right)\\ =\left(\$5,328-\$400\right)\\ =\$4,928\end{array}$

To determine

Prepare the adjusting entry on December 31 for allowance for doubtful accounts having a debit balance (using percentage of receivables method) and calculate the amount of net realizable value.

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.

Prepare 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	$6,085
	Allowance for doubtful accounts		$6,085
	(To adjust the allowance for doubtful accounts)

Table (4)

Working note 7:

Calculate the bad debt expense.

  $\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Total estimated uncollectibles under}\\ \text{the percentage-of-receivables basis + Debit}\\ \text{balance in allowance for doubtful accounts}\end{array}\right]\\ =\left[\$5,685+\$400\right]\\ =\$6,085\end{array}$

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.

Calculate the net realizable value of the accounts receivable:

$\begin{array}{c}\text{Net realizable value}=\left(\begin{array}{l}\text{Accounts receivable}-\\ \text{Allowance for doubtful accounts}\end{array}\right)\\ =\left(\text{\$30,000}-\$5,685\right)\\ =\$24,315\end{array}$

Working note 8:

Calculate the amount of allowance for doubtful accounts.

$\begin{array}{c}\text{Allowance for doubtful accounts =}\left(\begin{array}{l}\text{ Bad debt expense amount }-\\ \text{Debit balance of allowance for doubtful accounts }\end{array}\right)\\ =\left(\$6,085-\$400\right)\\ =\$5,685\end{array}$