Chapter 8, Problem 14E

Entries for bad debt expense under the direct write-off and allowance methods

The following selected transactions were taken from the records of Rustic Tables Company for the year ending December 31:

1. A. Journalize the transactions under the direct write-off method.
2. B. Journalize the transactions under the allowance method, assuming that the allowance account had a beginning balance of $36,000 at the beginning of the year and the company uses the analysis of receivables method. Rustic Tables Company prepared the following aging schedule for its accounts receivable:

1. C. How much higher (lower) would Rustic Tables’ net income have been under the direct write-off method than under the allowance method?

To determine

Prepare journal entry to record the transactions under direct write off method.

Answer to Problem 14E

Journalize the transactions of Company S under direct write off method.

Date	Particulars	Debit	Credit
June 8	Bad debt expense	$8,440
	Account receivable – Person KQ		$8,440
	(To record the write-off of uncollectible account receivable )
August 14	Cash	$3,000
	Bad debt expense	$9,500
	Account receivable – Person RO		$12,500
	(To record the cash collection and write-off of remaining uncollectible account receivable )
October 16	Accounts receivable – Person KQ	$8,440
	Bad debt expense		$8,440
	(The reinstate the account of Person KQ)
October 16	Cash	$8,440
	Accounts receivable – Person KQ		$8,440
	(To record collection of cash on account)
December 31	Bad debt expense	$24,995
	Account receivable – Person WD		$4,600
	Account receivable – Person GG		$3,600
	Account receivable – Person AK		$7,150
	Account receivable – Person SP		$2,975
	Account receivable – Person NS		$6,630
	(To record the write-off of uncollectible account receivable )
December 31	No entry is required

Table (1)

Explanation of Solution

Accounts receivable: Accounts receivable refers to the amounts to be received within a short period from customers upon the sale of goods and services on account. In other words, accounts receivable are amounts customers owe to the business. Accounts receivable is an asset of a business.

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.

Direct write-off method: This method does not make allowance or estimation for uncollectible accounts, instead this method directly write-off the actual uncollectible accounts by debiting bad debt expense and by crediting accounts receivable. Under this method, accounts would be written off only when the receivables from a customer remain uncollectible.

The explanation for the transactions is as follows:

For June 8:

To record this write-off of uncollectible receivables under direct write-off method, bad debt expense must be recognized as well as increased, and accounts receivable must be decreased by $8,440. Hence,

• • An increase in bad debt expense (decreases the stockholders’ equity accounts) is debited with $8,440, and
• • A decrease in accounts receivable (asset account) is credited with $8,440.

For August 14:

To record the collection of cash on account, cash account must be increased and accounts receivable must be decreased by $3,000.

To record this write-off of uncollectible receivables under direct write-off method, bad debt expense must be recognized as well as increased, and accounts receivable must be decreased by $9,500. Hence,

• • An increase in cash (asset account) is debited with $3,000
• • An increase in bad debt expense (decreases the stockholders’ equity accounts) is debited with $9,500, and
• • A decrease in accounts receivable (asset account) is credited with $\left(\$3,000+\$9,500\right)$ $12,500.

For October 16:

On October 16, the company has recovered $8,440 from Person KQ in full, whose account is previously written off as uncollectible. Hence, company required reversing the entry, which is previously written off as uncollectible receivables. Hence,

• • Accounts receivable (asset account) is debited to increase its balance by $8,440, and
• • Bad debt expense (stockholders’ equity) is credited to decrease its balance by $8,440.

Now, the collection of cash on account, increases cash and decreases accounts receivable by $8,440, as company has collected its receivables. Hence,

• • An increase in cash (asset account) is debited with $8,440, and
• • A decrease in accounts receivable (asset account) is credited with $8,440.

For December 31:

To record this write-off of uncollectible receivables under direct write-off method, bad debt expense must be recognized as well as increased, and accounts receivable must be decreased. Hence,

• • An increase in bad debt expense (decreases the stockholders’ equity accounts) is debited, and
• • A decrease in accounts receivable (asset account) is credited.

Adjusting entry is not required under direct write off method, since this method used to write off the accounts receivable accounts only when it is determined to be worthless.

To determine

Prepare journal entry to record the transactions under allowance method (Aging analysis method).

Answer to Problem 14E

Journalize the transactions of Company RT under allowance method.

Date	Particulars	Debit	Credit
June 8	Allowance for doubtful accounts	$8,440
	Account receivable – Person KQ		$8,440
	(To record the write-off of uncollectible account receivable )
August 14	Cash	$3,000
	Allowance for doubtful accounts	$9,500
	Account receivable – Person RO		$12,500
	(To record the cash collection and write-off of remaining uncollectible account receivable )
October 16	Accounts receivable – Person KQ	$8,440
	Allowance for doubtful accounts		$8,440
	(The reinstate the account of Person S)
October 16	Cash	$8,440
	Accounts receivable – Person KQ		$8,440
	(To record collection of cash on account)
December 31	Allowance for doubtful accounts	$24,955
	Account receivable – Person WD		$4,600
	Account receivable – Person GG		$3,600
	Account receivable – Person AK		$7,150
	Account receivable – Person SP		$2,975
	Account receivable – Person NS		$6,630
	(To record the write-off of uncollectible account receivable )
December 31	Bad debt expense (1)	$45,545
	Allowance for doubtful accounts		$45,545
	(To adjust the allowance for doubtful accounts)

Table (2)

Explanation of Solution

Allowance method: It is a method for accounting bad debt expense, where amount of 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:

• • Percentage of sales method, and
• • Analysis of receivables method.

Analysis of receivables method: A method of determining the estimated uncollectible receivables based on the age of individual accounts receivable is known as analysis of receivables method. This method is otherwise known as aging of receivables method. Under analysis of receivables method, estimated bad debts would be treated as the desired adjusted balance for allowance for doubtful accounts.

Working note 1: Estimate the balance of the allowance for doubtful accounts as of December 31 using aging schedule.

Age interval	Balance	Estimated uncollectible accounts
		Percent	Amount
1-30 days past due	$320,000	1%	$3,200
31-60 days past due	$110,000	3%	$3,300
61-90 days past due	$24,000	10%	$2,400
91-120 days past due	$18,000	33%	$5,940
More than 120 days	$43,000	75%	$32,250
Total	$515,000		$47,090

Table (3)

The aging of accounts receivable indicates that the total estimated allowance for doubtful accounts as of December 31 is $47,090.

Prepare T-account for allowance for doubtful accounts to determine the unadjusted balance of allowance account.

Allowance for doubtful accounts
Date	Particulars	Debit	Date	Particulars	Credit
June 8	Accounts receivable	$8,440	January 1	Beginning balance	$36,000
August 14	Accounts receivable	$9,500	October 16	Accounts receivable	$8,440
December 31	Accounts receivable	$24,955
	Total	$42,895		Total	$44,440
				Ending balance	$1,545

Table (4)

Now, calculate the amount of bad debt expense to be recorded in adjusting entry.

  $\begin{array}{c}\begin{array}{l}\text{Bad debt expense to be}\\ \text{recorded in adjusting entry}\end{array}\}\text{= }\left[\begin{array}{l}\text{Estimated balance for allowance}\\ \text{for doubtful accounts}-\\ \text{Unadjusted debit balance in allowance}\\ \text{for doubtful accounts}\end{array}\right]\\ \text{=}\left[\text{\$47,090}-\$1,545\right]\\ =\$45,545\end{array}$

For June 8:

To record this write-off of uncollectible receivables under allowance method, both allowance for doubtful accounts and accounts receivable must be decreased by $8,440. Hence,

• • A decrease in Allowance for doubtful accounts (contra-asset accounts) is debited with $8,440.
• • A decrease in accounts receivable (asset account) is credited with $8,440.

For August 14:

To record the collection of cash on account, cash account must be increased and accounts receivable must be decreased by $3,000.

To record this write-off of uncollectible receivables under allowance method, both allowance for doubtful accounts and accounts receivable must be decreased by $9,500. Hence,

• • An increase in cash (asset account) is debited with $3,000,
• • A decrease in Allowance for doubtful accounts (contra-asset accounts) is debited with $9,500, and
• • A decrease in accounts receivable (asset account) is credited with  $\left(\$3,000+\$9,500\right)$ $12,500.

For October 16:

On October 16, Company RT has recovered $8,440 from Person KQ in full, whose account is previously written off as uncollectible. Hence, company should reverse the entry, which is previously written off as uncollectible receivables. Hence,

• • Accounts receivable (asset account) is debited to increase its balance by $8,440, and
• • Allowance for doubtful accounts (contra-asset account) is credited to increase its balance by $8,440.

Now, the collection of cash on account, increases cash and decreases accounts receivable by $8,440, as company has collected its receivables. Hence,

• • An increase in cash (asset account) is debited with $8,440, and
• • A decrease in accounts receivable (asset account) is credited with $8,440.

For December 31:

To record this write-off of uncollectible receivables under allowance method, both allowance for doubtful accounts and accounts receivable must be decreased.

• • A decrease in Allowance for doubtful accounts (contra-asset accounts) is debited and,
• • A decrease in accounts receivable (asset account) is credited.

Adjusting entry is required at the end of the year, under allowance method. Aging receivables method is followed; hence estimated bad debts would be treated as ending balance of allowance account. Allowance for doubtful accounts (contra asset account) normal balance is a credit balance, it is calculated and determined that the unadjusted balance of Allowance for doubtful accounts as of December 31 is a credit of $1,545. It is calculated that total estimated allowance for doubtful accounts as of December 31 is $47,090. Hence, to bring the allowance for doubtful account balance from a credit of $1,545 to a credit of $47,090, it is required to increase bad debt expense and allowance for doubtful accounts by $45,545.

Hence, an increase in bad debt expense (decrease in stockholders’ equity account) is debited with $45,545 and an increase in allowance for doubtful accounts (contra asset account) is credited with $$45,545.

To determine

Determine whether net income of Company RT is higher or lower under the direct-write off method than allowance method.

Explanation of Solution

Determine whether net income of Company RT is higher or lower under the direct-write off method than allowance method.

Bad debt expense under:	Amount
Allowance method (1)	$45,545
Direct-write off method (2)	$34,445
Difference	$11,090

Table (5)

Bad debt expense under allowance method is higher than direct write-off method. Increase in expense decreases the net income. Hence, Company RT’s net income would have been higher under the direct write off method than the allowance method by $11,090.

Working note 2: Prepare T-account for bad debt expense account (for direct write off method).

Bad debt expense account
Date	Particulars	Debit	Date	Particulars	Credit
June 8	Accounts receivable	$8,840	October 16	Accounts receivable	$8,440
August 14	Accounts receivable	$9,500
December 31	Accounts receivable	$24,955
	Total	$42,895		Total	$8,440
	Ending balance	$34,445

Table (6)