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Chapter 7: 1CA (page 376)

Simms Company has significant amounts of trade accounts receivable. Simms uses the allowance method to estimate bad debts instead of the direct write-off method. During the year, some specific accounts were written off as uncollectible, and some that were previously written off as uncollectible were collected.

Instructions

(a) What are the deficiencies of the direct write-off method?

(b) Briefly describe the allowance method to estimate bad debts and the theoretical justification for its use?

(c) How should Simms account for the collection of the specific accounts previously written off as uncollectible?

Short Answer

Expert verified
  1. Matching principle of accounting is not followed under the direct write-off method.
  2. Net realizable value of accounts receivable is calculated under the allowance method.
  3. One entry for the re-statement of accounts receivables and one entry for cash collection.

Step by step solution

01

Definition of Net Realizable Value

The value representing the amount of money that can be generated through the sale of the current asset is known as net realizable value.

02

Deficiencies of direct-write off method

Under the direct write-off method, the accounts receivables are not reported on their net realizable value. It also does not write off bad debts in the same period of revenue generation and therefore does not comply with the matching principle.

03

Justification of allowance method

The allowance method is theoretically justified because it reports the accounts receivables on their net realizable value. Under the allowance method, the bad debts are estimated as a percentage of the balance of accounts receivables.

04

Reporting recovery of bad debts

Two journal entries will be made:

Date

Accounts and Explanation

Debit $

Credit $

1

Accounts receivables

xxx

Allowance for doubtful accounts

xxx

2

Cash

xxx

Accounts receivables

xxx

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Most popular questions from this chapter

GROUPWORK (Income Effects of Receivables Transactions) Sandburg Company requires additional cash for its business. Sandburg has decided to use its accounts receivable to raise the additional cash and has asked you to determine the income statement effects of the following contemplated transactions.

1. On July 1, 2017, Sandburg assigned \(400,000 of accounts receivable to Keller Finance Company. Sandburg received an advance from Keller of 80% of the assigned accounts receivable less a commission of 3% on the advance. Prior to December 31, 2017, Sandburg collected \)220,000 on the assigned accounts receivable, and remitted \(232,720 to Keller, \)12,720 of which represented interest on the advance from Keller.

2. On December 1, 2017, Sandburg sold \(300,000 of net accounts receivable to Wunsch Company for \)270,000. The receivables were sold outright on a without recourse basis.

3. On December 31, 2017, an advance of \(120,000 was received from First Bank by pledging \)160,000 of Sandburg鈥檚 accounts receivable. Sandburg鈥檚 first payment to First Bank is due on January 30, 2018.

Instructions

Prepare a schedule showing the income statement effects for the year ended December 31, 2017, as a result of the above facts.

Computing Bad Debts and Preparing Journal Entries) The trial balance before adjustment of Taylor Swift Inc. shows the following balances.

Debit

Credit

Accounts Receivable

\(90,000

Allowance for Doubtful Accounts

1,750

Sales revenue (all on credit)

\)680,000

Instructions

Give the entry for estimated bad debts assuming that the allowance is to provide for doubtful accounts on the basis of (a) 4% of gross accounts receivable and (b) 5% of gross accounts receivable and Allowance for Doubtful Accounts has a $1,700 credit balance.

Finman Company designated Jill Holland as petty cash custodian and established a petty cash fund of \(200. The fund is reimbursed when the cash in the fund is at \)15, which it is. Petty cash receipts indicate funds were disbursed for office supplies \(94 and miscellaneous expense \)87. Prepare journal entries for the establishment of the fund and the reimbursement.

(Accounting for Zero-Interest-Bearing Note) Soon after beginning the year-end audit work on March 10 at Engone Company, the auditor has the following conversation with the controller.

Controller: The year ended March 31st should be our most profitable in history and, as a consequence, the board of directors has just awarded the officers generous bonuses.

Auditor: I thought profits were down this year in the industry, according to your latest interim report.

Controller: Well, they were down, but 10 days ago we closed a deal that will give us a substantial increase for the year.

Auditor: Oh, what was it?

Controller: Well, you remember a few years ago our former president bought stock in Henderson Enterprises because he had those grandiose ideas about becoming a conglomerate. For 6 years we have not been able to sell this stock, which cost us \(3,000,000 and has not paid a nickel in dividends. Thursday we sold this stock to Bimini Inc. for \)4,000,000. So, we will have a gain of \(700,000 (\)1,000,000 pretax) which will increase our net income for the year to \(4,000,000, compared with last year鈥檚 \)3,800,000. As far as I know, we鈥檒l be the only company in the industry to register an increase in net income this year. That should help the market value of the stock!

Auditor: Do you expect to receive the \(4,000,000 in cash by March 31st, your fiscal year-end?

Controller: No. Although Bimini Inc. is an excellent company, they are a little tight for cash because of their rapid growth. Consequently, they are going to give us a \)4,000,000 zero-interest-bearing note with payments of $400,000 per year for the next 10 years. The first payment is due on March 31 of next year.

Auditor: Why is the note zero-interest-bearing?

Controller: Because that鈥檚 what everybody agreed to. Since we don鈥檛 have any interest-bearing debt, the funds invested in the note do not cost us anything and besides, we were not getting any dividends on the Henderson Enterprises stock.

Instructions

Do you agree with the way the controller has accounted for the transaction? If not, how should the transaction be accounted for?

Wilton, Inc. had net sales in 2017 of \(1,400,000. At December 31, 2017, before adjusting entries, the balances in selected accounts were Accounts Receivable \)250,000 debit, and Allowance for Doubtful Accounts $2,400 credit. If Wilton estimates that 8% of its receivables will prove to be uncollectible, prepare the December 31, 2017, journal entry to record bad debt expense.
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