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Chapter 7: Question 10 (page 362)

Indicate how the percentage-of-receivables method, based on an aging schedule, accomplishes the objectives of the allowance method of accounting for bad debts. What other methods, besides an aging analysis, can be used for estimating uncollectible accounts?

Short Answer

Expert verified

Percentage method reports account receivables on net realizable value in the balance sheet. A business entity can use other methods such ascredit rating.

Step by step solution

01

Definition of Credit Ratings

The ratings given to each debtor that depicts their ability to repay a loan is known as credit rating. It is provided based onprevious loan payments.

02

Accomplishment of Objective by Percentage-of-Receivables Method

Underpercentage method, a business entity calculates bad debt expenses and allowance for doubtful debts byassessing the collectability of the opening receivables at the end of the year. Such assessment is done based on their due dates. Different age categories are established, and percentage rates for each age category are allotted. Such allotment is made based on previous experience. A business entity can also use analysis to estimateuncollectible receivables that are due from prior periods. The estimated uncollectible accounts are then adjusted with the accounts receivables on the balance sheet.

This method proves to be accurate because the accounts receivables under this method are reported on their net realizable value on the balance sheet. Still, it might not be accurate according tomatching principlebecause bad debt expenses do not match the sales instead it causes them.

03

Other Methods That Can be Used

A business entity can adopt loss ratios for customers and allot different credit ratings to each customer. A company can also usediscounted cash flow model representing the probability of collection.

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Most popular questions from this chapter

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.

Clark Pierce conducts a wholesale merchandising business that sells approximately 5,000 items per month with a total monthly average sales value of $250,000. Its annual bad debt rate has been approximately 1陆% of sales. In recent discussions with his bookkeeper, Mr. Pierce has become confused by all the alternatives apparently available in handling the Allowance for Doubtful Accounts balance. The following information has been presented to Pierce.

1. An allowance can be set up (a) on the basis of a percentage of receivables or (b) on the basis of a valuation of all past due or otherwise questionable accounts receivable. Those considered uncollectible can be charged to such allowance at the close of the accounting period, or specific items can be charged off directly against (1) Gross Sales or to (2) Bad Debt Expense in the year in which they are determined to be uncollectible.

2. Collection agency and legal fees, and so on, incurred in connection with the attempted recovery of bad debts can be charged to (a) Bad Debt Expense, (b) Allowance for Doubtful Accounts, (c) Legal Expense, or (d) Administrative Expense.

3. Debts previously written off in whole or in part but currently recovered can be credited to (a) Other Revenue, (b) Bad Debt Expense, or (c) Allowance for Doubtful Accounts.

Instructions

Which of the foregoing methods would you recommend to Mr. Pierce in regard to (1) allowances and charge-offs, (2) collection expenses, and (3) recoveries? State briefly and clearly the reasons supporting your recommendations.

(Notes Receivable Journal Entries) On December 31, 2017, Oakbrook Inc. rendered services to Beghun Corporation at an agreed price of \(102,049, accepting \)40,000 down and agreeing to accept the balance in four equal installments of $20,000 receivable each December 31. An assumed interest rate of 11% is imputed.

Instructions

Prepare the entries that would be recorded by Oakbrook Inc. for the sale and the receipts and interest on the following dates (prepare an amortization schedule). (Assume that the effective-interest method is used for amortization purposes.)

(a) December 31, 2017.

(b) December 31, 2018.

(c) December 31, 2019.

(d) December 31, 2020.

(e) December 31, 2021.

(Assigning Accounts Receivable) On April 1, 2017, Rasheed Company assigns \(400,000 of its accounts receivable to the Third National Bank as collateral for a \)200,000 loan due July 1, 2017. The assignment agreement calls for Rasheed to continue to collect the receivables. Third National Bank assesses a finance charge of 2% of the accounts receivable, and interest on the loan is 10% (a realistic rate of interest for a note of this type).

Instructions

(a) Prepare the April 1, 2017, journal entry for Rasheed Company.

(b) Prepare the journal entry for Rasheed鈥檚 collection of $350,000 of the accounts receivable during the period from April 1, 2017, through June 30, 2017.

(c) On July 1, 2017, Rasheed paid Third National all that was due from the loan it secured on April 1, 2017. Prepare the journal entry to record this payment.

Under IFRS, receivables are to be reported on the balance sheet at:

(a) amortized cost.

(b) amortized cost adjusted for estimated loss provisions.

(c) historical cost.

(d) replacement cost.
See all solutions

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