Chapter 8, Problem 4PA

Accounting for Accounts and Notes Receivable Transactions

Web Wizard, Inc., has provided information technology services for several years. The company uses the percentage of credit sales method to estimate bad debts for internal monthly reporting purposes. At the end of each quarter, the company adjusts its records using the aging of accounts receivable method. The company entered into the following partial list of transactions during the first quarter.

1. a. During January, the company provided services for $40,000 on credit.
2. b. On January 31, the company estimated bad debts using 1 percent of credit sales.
3. c. On February 4, the company collected $20,000 of accounts receivable.
4. d. On February 15, the company wrote off a $100 account receivable.
5. e. During February, the company provided services for $30,000 on credit.
6. f. On February 28, the company estimated bad debts using 1 percent of credit sales.
7. g. On March 1, the company loaned $2,400 to an employee who signed a 6% note, due in 6 months.
8. h. On March 15, the company collected $100 on the account written off one month earlier.
9. i. On March 31, the company accrued interest earned on the note.
10. j. On March 31, the company adjusted for uncollectible accounts, based on an aging analysis (below). Allowance for Doubtful Accounts has an unadjusted credit balance of $1,200.

Required:

1. 1. For items (a)–(j), analyze the amount and direction (+ or −) of effects on specific financial statement accounts and the overall accounting equation.
2. 2. Prepare journal entries for items (a)–(j).
3. 3. Show how Accounts Receivable. Notes Receivable, and their related accounts would be reported in the current assets section of a classified balance sheet.
4. 4. Sales Revenue and Service Revenue are two income statement accounts that relate to Accounts Receivable. Name two other accounts related to Accounts Receivable and Notes Receivable that would be reported on the income statement and indicate whether each would appear before, or after, Income from Operations.

To determine

To indicate: The amount and direction of effects of each transaction from (a)-(j) on the financial statement accounts and on the overall accounting equation.

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 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.

Write-off:

Write-off refers to the deduction of a certain amount from accounts receivable, when it is decided that the amount would be uncollectible forever.

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Shareholders Equity}$

Indicate the amount and direction of effects each transactions on the financial statement accounts and on the overall accounting equation.

a.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Accounts receivable	+$40,000				Service revenue (+R)	+$40,000

Table (1)

b.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Allowance for doubtful accounts (+xA)	–$400				Bad debt expense (+E)	–$400

Table (2)

Working note:

Determine the amount of bad debt expense for the year.

$\begin{array}{c}\text{Bad debt expense for the year=}\left[\begin{array}{l}\text{Credit sales }\times \text{Estimated bad debt}\\ \text{expense in percentage of sales}\end{array}\right]\\ \text{=\$40,000}\times \left(1\%\text{ of sales}\right)\\ =\$400\end{array}$

c.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Cash	+$20,000
Accounts receivable	–$20,000

Table (3)

d.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Accounts receivable	–$100
Allowance for doubtful accounts (–xA)	+$100

Table (4)

e.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Accounts receivable	+$30,000				Service revenue (+R)	+30,000

Table (5)

f.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Allowance for doubtful accounts (+xA)	–$300				Bad debt expense (+E)	–$300

Table (6)

g.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Cash	–$2,400
Note receivable	+$2,400

Table (7)

h.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Accounts receivable	+$100
Allowance for doubtful accounts (+xA)	–$100
Cash	+$100
Accounts receivable	–$100

Table (8)

i.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Interest receivable	+$12				Interest revenue (+R)	+$12

Table (9)

Working note:

Calculate the amount of interest revenue earned on note, as on March 31.

$\begin{array}{c}\text{Interest Receivable = }\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \text{Number of month for which interest accrued}\end{array}\right]\\ =\left[\begin{array}{c}\text{Notes Receivable}\times \text{ Interest Percentage}\times \\ \left(\frac{\text{March 1 to March 31}}{12\text{ months}}\right)\end{array}\right]\\ \text{= \$2,400}\times 6\text{\%}\times \frac{\text{1 month}}{12\text{months}}\\ =\text{\$12}\end{array}$

j.

Assets	Amount	=	Liabilities	+	Stockholders’ equity	Amount
Allowance for doubtful accounts (+xA)	–$478				Bad debt expense (+E)	–$478

Table (10)

Working note:

Estimate the amount of uncollectible under on the basis of aging analysis method.

	Number of days unpaid
	Total	0–30	31–60	61–90	Over 90
Total Accounts Receivable	$ 18,000	$7,300	$8,480	$1,020	$1,200
Estimated Uncollectible (%)		$\times$2%	$\times$10%	$\times$ 20%	$\times$40%
Estimated Uncollectible ($)	$ 1,678	$146	$848	$204	$480

Table (11)

Aging of receivables method:

A method of determining the estimated uncollectible receivables based on the age of individual accounts receivable is known as aging of receivables method. Amount of accounts receivables of different age and its respective uncollectible percentage are multiplied, to determine the estimated uncollectible receivables for each age group of receivable.

It is given that the unadjusted balance of allowance for doubtful accounts is a credit balance of $1,200. It is calculated that the estimated uncollectible is $1,678. Under aging of receivables method, estimated uncollectible would be treated as desired ending balance of allowance for doubtful accounts. To bring the balance of allowance for doubtful accounts from a credit balance of $1,200 to a credit of $1,678, allowance for doubtful accounts must be adjusted (by debiting (increasing) bad debts expenses and by crediting (increasing) allowance for doubtful accounts). So, now calculate the amount needed to be adjusted for uncollectible accounts.

Calculate the amount needed to be adjusted for uncollectible accounts.

$\begin{array}{c}\begin{array}{l}\text{Amount to be adjusted}\\ \text{for uncollectible accounts}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Total estimated uncollectibles}-\text{Credit}\\ \text{balance in unadjusted allowance for}\\ \text{doubtful accounts}\end{array}\right]\\ =\left[\$1,678-\text{\$1,200}\right]\\ =\$478\end{array}$

Thus, the amount needed to be adjusted for uncollectible accounts is $478.

Note:

xA denotes contra asset account

R denotes revenue account

E denotes expenses account

To determine

To prepare: Journal entries for items from (a) to (j).

Explanation of Solution

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Prepare journal entries for items from (a) to (j) as follows:

Item	Date	Account Title and Explanation	Debit ($)	Credit ($)
a.	January	Accounts Receivable (+A)	40,000
		Service Revenue (+R)		40,000
		(To record service rendered on credit)
b.	January 31	Bad debt expense (+E)	400
		Allowance for doubtful accounts (+xA)		400
		(To record the estimated bad debt expense)
c.	February 4	Cash (+A)	20,000
		Accounts receivable (–A)		20,000
		(To record the collection of cash on account)
d.	February 15	Allowance for doubtful accounts (–xA)	100
		Accounts receivable (–A)		100
		(To record the write off of receivables)
e.	February	Accounts Receivable (+A)	30,000
		Service Revenue (+R)		30,000
		(To record service rendered on credit)
f.	February 28	Bad debt expense (+E)	300
		Allowance for doubtful accounts (+xA)		300
		(To record the estimated bad debt expense)
g.	March 1	Note Receivable (+A)	2,400
		Cash (–A)		2,400
		(To recordthe acceptance of note)
h.	March 15	Accounts Receivable (+A)	100
		Allowance for doubtful accounts (+xA)		100
		(To reverse the written off receivables)
	March 15	Cash (+A)	100
		Accounts receivable (–A)		100
		(To record the collection of cash on account)
i.	March 31	Interest Receivable (+A)	12
		Interest Revenue (+R)		12
		(To record accrued interest earned on note)
j.	March 31	Bad debt expense (+E)	478
		Allowance for doubtful accounts (+xA)		478
		(To record the estimated bad debt expense)

Table (12)

Note:

A denotes asset account, xA denotes contra-asset account, R denotes revenue account, and E denotes expenses account.

To determine

To show: How accounts receivable, notes receivable, and their related accounts would be reported in the current asset section of the classified balance sheet at the end of quarter on March 31.

Explanation of Solution

Prepare partial classified balance sheet at the end of quarter on March 31 as follows:

Incorporation W
Classified balance sheet (Partial)
At the end of quarter on March 31
Assets:	Amount in $	Amount in $
Current assets:
Accounts receivable	18,000
Less: Allowance for doubtful accounts	(1,678)
Accounts receivable, net of allowance		16,322
Notes receivable		2,400
Interest receivable		12

Table (13)

To determine

To identify: Two accounts (apart from sales revenue and service revenue) that are related to accounts receivable and notes receivable that would be reported on the income statement.

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.

Bad debt expense account is an account which is related to accounts receivables, which would be reported as bad debt expense on the income statement before income from operations.

Interest revenue account is an account which is related to notes receivables, which would be reported as interest revenue on the income statement after income from operations.