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Chapter 8: Problem 15

When a previously written-off account receivable is collected, it must first be reinstated by debiting the Accounts Receivable account and crediting the Allowance for Doubtful Accounts. Explain the credit portion of the reinstatement journal entry.

Short Answer

Expert verified
Credit the Allowance for Doubtful Accounts to reduce the allowance set for bad debts as the account is reinstated.

Step by step solution

01

Identify the Accounts Involved

When a previously written-off account receivable is collected, the two primary accounts involved in reinstatement are 'Accounts Receivable' and 'Allowance for Doubtful Accounts'. These accounts are used to reflect the re-establishment of the receivable and the reversal of the previous doubtful account estimate.
02

Understanding Allowance for Doubtful Accounts

The Allowance for Doubtful Accounts is a contra-asset account used to estimate the amount of accounts receivable that will not be collected. It is credited when accounts are reinstated because this reduces the allowance that was initially set aside for bad debts.
03

Journal Entry for Reinstatement

To reinstate the account, you must make a journal entry. The entry involves debiting Accounts Receivable to show that the account is again expected to be collected, and crediting Allowance for Doubtful Accounts, which reflects that the allowance for bad debts is reduced by the reinstated amount.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Accounts Receivable
Accounts Receivable represents money owed to a business by its customers for products or services already delivered. It鈥檚 an asset because it will, in time, bring cash into the business, thereby benefitting the company financially.

When goods or services are provided on credit, a book entry is recorded in the accounts receivable ledger. This helps a business track who owes them money and how much.

Here's how it works:
  • Accounts receivable increases when a credit sale is made.
  • It decreases when customers make payments.
  • It plays a crucial role in working capital management and liquidity assessment.
A properly managed accounts receivable ensures the company's cash flow remains healthy, enabling better financial planning and operational efficiency.
Allowance for Doubtful Accounts
Allowance for Doubtful Accounts is essential in financial accounting for adjusting receivables realistically. This account estimates the portion of accounts receivable that may go uncollected due to various reasons restricting full payment by customers.

The allowance is crucial due to several reasons:
  • It ensures that financial statements present a fair picture of the company's financial health.
  • It shields a business from unexpected financial turbulence due to bad debts.
  • It helps in making realistic projections about the company's future cash flows.

By creating this allowance, a company practices prudent accounting, preparing for potential losses proportionate to historical data and customer payment patterns.
Journal Entry
A journal entry in accounting records every business transaction in the company鈥檚 books systematically. This process captures the movement of money in and out of the business, ensuring financial accuracy.

For reinstating a written-off account receivable, the journal entry involves two main elements:
  • Debit: Accounts Receivable, to reinstate the amount expected to be received.
  • Credit: Allowance for Doubtful Accounts, as the need for this allowance is reduced.
The journal description provides a clear record of the steps taken to adjust the accounts, making it easy to track changes to a company's financial standing and ensuring accurate reports are generated.
Contra-Asset Account
A contra-asset account is used in accounting to directly reduce the value of a related account, providing a clearer view of a company鈥檚 true financial situation.

Contra-asset accounts are crucial as they:
  • Allow businesses to maintain the actual historical cost of an asset while also adjusting for depreciation or potential uncollectible amounts.
  • Aid in accurately reporting the net values of assets on financial statements.
  • Enable easy comparisons and interpretations of the true economic value of the business鈥檚 assets.
An example is the Allowance for Doubtful Accounts, which pairs with Accounts Receivable. By using this contra-account, companies can project more reliable financial results about their expected income.

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Most popular questions from this chapter

Allowance Method Brooke Company, which has been in business for three years, makes all of its sales on account and does not offer cash discounts. The firm's credit sales, collections from customers, and write-offs of uncollectible accounts for the three-year period are summarized as follows: \begin{tabular}{crrr} Year & Sales & Collections & Accounts Written Off \\ 2018 & \(\$ 751,000\) & \(\$ 733,000\) & \(\$ 5,300\) \\ 2019 & 876,000 & 864,000 & 6,400 \\ 2020 & 980,000 & 938,000 & 6,500 \\ \hline \end{tabular} Required a. If Brooke Company used an allowance method of recognizing credit losses and provided for such losses at the rate of one percent of credit sales, what amounts of accounts receivable and the allowance for doubtful accounts should appear on the firm's balance sheet at the end of 2020 ? What total amount of bad debts expense should appear on the firm's income statement during the three-year period? b. Comment on the use of the one percent rate to provide for credit losses in part \(a\).

Allowance Method versus Direct Write-Off Method On April 12, Mitch Company declared a \(\$ 2,000\) account receivable from the Ward Company as uncollectible and wrote off the account. On December 5 , Mitch received a \(\$ 600\) payment on the account from Ward. a. Assume that Mitch uses the allowance method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Ward's account. c. Assume that the payment from Ward arrives on the following January 18 , rather than on December 5 of the current year. (1) Prepare the journal entries to record the write-off and subsequent recovery of Ward's account under the allowance method. (2) Prepare the journal entries to record the write-off and subsequent recovery of Ward's account under the direct write-off method. b. Assume that Mitch uses the direct write-off method of handling credit losses. Prepare the journal entries to record the write-off and the subsequent recovery of Ward's account.

Credit Losses Based on Accounts Receivable Miller, Inc., analyzed its accounts receivable balances at December 31 and arrived at the aged balances listed below, along with the percentage that is estimated to be uncollectible: The company handles credit losses using the allowance method. The credit balance of the Allowance for Doubtful Accounts is \(\$ 1,150\) on December 31 , before any adjustments. a. Prepare the adjusting entry for estimated credit losses on December 31 . b. Prepare the journal entry to write off the Lyons Company's account on April 10 of the following year in the amount of \(\$ 575\).

How do the allowance method and the direct write-off method of handling credit losses differ with respect to the timing of bad debts expense recognition?

Journal Entries for Credit Losses At January 1, the Blake Company had the following accounts on its books: During the year, credit sales were \(\$ 850,000\) and collections on account were \(\$ 794,000\). The following transactions, among others, occurred during the year: Jan. 11 Wrote off J. Wolf's account, \(\$ 3,000\). Apr. 29 Wrote off B. Avery's account, \(\$ 2,000\). Nov. 15 Received \(\$ 1,000\) from B. Avery to pay a debt that had been written off April 29 . This amount is not included in the \(\$ 794,000\) collections. Dec. 5 Wrote off D. Wright's account, \(\$ 2,250\). 31 In an adjusting entry, recorded the allowance for doubtful accounts at one percent of credit sales for the year. Required a. Prepare journal entries to record the credit sales, the collections on account, the transactions, and the adjustment. b. Show how Accounts Receivable and the Allowance for Doubtful Accounts appear on the December 31 balance sheet.
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