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Chapter 8: Problem 3

Estimating the Bad Debts Expense Winter \& Company has accounts receivable of \(\$ 120,000\) and a debit balance of \(\$ 1,000\) in the Allowance for Doubtful Accounts. Two-thirds of the accounts receivable are current and one-third is past due. The firm estimates that two percent of the current accounts and five percent of the past due accounts will prove to be uncollectible. The adjusting entry to provide for the bad debts expense under the aging method should be for what amount? a. \(\$ 3,600\) c. \(\$ 2,600\) b. \(\$ 4,600\) d. \(\$ 1,600\)

Short Answer

Expert verified
The adjusting entry for bad debts expense should be \(\$2,600\).

Step by step solution

01

Identify Current and Past Due Accounts

First, calculate the current and past due accounts from the total accounts receivable. Since two-thirds of the accounts are current and one-third is past due, we can define them as follows: current accounts are \( \frac{2}{3} \times 120,000 = 80,000 \), and past due accounts are \( \frac{1}{3} \times 120,000 = 40,000 \).
02

Calculate Estimated Uncollectible Amount for Current Accounts

Apply the firm's estimate for uncollectible current accounts. This is 2% of the current accounts: \( 0.02 \times 80,000 = 1,600 \).
03

Calculate Estimated Uncollectible Amount for Past Due Accounts

Apply the firm's estimate for uncollectible past due accounts. This is 5% of the past due accounts: \( 0.05 \times 40,000 = 2,000 \).
04

Calculate Total Estimated Bad Debts

Add the uncollectible amounts calculated for current and past due accounts: \( 1,600 + 2,000 = 3,600 \). This is the total estimated bad debt expense needed for adjustment.
05

Determine the Adjusting Entry Amount

Since there is already a debit balance of \( 1,000 \) in the Allowance for Doubtful Accounts, you need to adjust it to reflect the total estimated bad debts of \( 3,600 \). Therefore, the adjusting entry should be: \( 3,600 - 1,000 = 2,600 \).

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Key Concepts

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

Allowance for Doubtful Accounts
The Allowance for Doubtful Accounts is a financial safeguard used to estimate potential future losses from uncollectible accounts. It's an essential component in accounting because not all customers will be able to pay their debts. Similar to a rainy day fund, it prepares a company for accounts receivable they won't be able to collect. This account ensures that financial statements present a realistic picture of a company's financial health.
  • It is adjusted regularly based on different estimation methods, one of which is the aging method.
  • Adjustments affect the income statement through the bad debts expense.
  • Reflects the business's experience with credit losses and expectations for the future.
Aging Method
The aging method is a common technique for estimating the amount of uncollectible receivables. It organizes accounts receivable based on how long they have been outstanding, as overdue accounts are less likely to be collected. This method is effective in identifying which accounts are at higher risk of default.
  • Breaks down receivables into categories, often by 30-day increments, such as current, 1-30 days past due, 31-60 days past due, etc.
  • Assigns a higher uncollectible percentage to older accounts.
  • Allows businesses to adjust quickly to changes in customer payment behavior and economic conditions.
In the exercise, Winter & Company uses this method to determine the appropriate amount for bad debt estimation by applying a higher percentage to past due accounts.
Accounts Receivable
Accounts Receivable refers to the money owed to a company by its customers for goods or services delivered but not yet paid for. It is considered an asset as it represents a future inflow of cash.
  • This account fluctuates considering the volume of credit sales and customer payments.
  • Monitoring accounts receivable is crucial for maintaining healthy cash flow.
  • A higher balance might indicate growing sales or potential collection issues.
In our scenario, Winter & Company's accounts receivable balance of $120,000 needs careful management to ensure it won't all turn into bad debts.
Uncollectible Accounts Estimation
Estimating uncollectible accounts means predicting which portions of accounts receivable will not be collected. This estimate is crucial for creating a realistic Allowance for Doubtful Accounts.
  • Requires analyzing historical data and current trends in customer payments.
  • Utilizes varying approaches, such as percentages based on aging categories.
  • Affects the net value of accounts receivable on the balance sheet.
For Winter & Company, the chosen estimates were 2% for current accounts and 5% for past-due accounts, guiding them to the calculated bad debt expense using the aging method.

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Most popular questions from this chapter

Accounts Receivable Turnover Taver Company has net sales of \(\$ 120,000\), a beginning balance in Accounts Receivable of \(\$ 10,000\), and an ending balance in Accounts Receivable of \(\$ 14,000\). What is the company's accounts receivable turnover? a. \(10.0\) b. \(12.0\) c. \(8.6\) d. \(9.2\)

Credit Card Sales Captain Peter's Marina sells boats and other water recreational vehicles (approximately three vehicles are sold each week). The following transactions occurred during the third week of May: May 15 Sold an \(\$ 800\) boat trailer ( \(\$ 500\) cost) to Sam and Myrna Marston, who paid using a personal check. 16 Sold a \(\$ 10,000\) boat \((\$ 6,500\) cost) to the Calumet Lake Patrol on account, with \(2 / 10, n / 30\) terms. 18 Sold a \(\$ 1,200\) water scooter (\$700 cost) to Kyle Bronson, who used the United Merchants Card to charge the cost of the water scooter. Captain Peter's mailed the credit card sales slip to United Merchants the same day. United Merchants will send a check within seven days, net of a two percent fee. 19 Sold a \(\$ 6,000\) fishing boat \((\$ 3,500\) cost \()\) to Michael Ferguson, who used the Great American Bank Card to pay for the boat. Captain Peter's deposited the credit card sales slip the same day and received an immediate credit in the company's checking account, net of a three percent fee. 20 Received payment from Calumet Lake Patrol for the boat purchased on May \(16 .\) 21 Received payment from United Merchants for the May 18 transaction. Required Prepare journal entries to record these transactions. Captain Peter's Marina uses the perpetual inventory system.

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 \(a\).

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?

Haley Company estimates its bad debts expense by aging its accounts receivable and applying percentages to various age groups of the accounts. Haley calculated a total of \(\$ 2,100\) in possible credit losses as of December 31 . Accounts Receivable has a balance of \(\$ 98,000\), and the Allowance for Doubtful Accounts has a credit balance of \(\$ 500\) before adjustment at December 31 . What is the December 31 adjusting entry to provide for credit losses? What is the net amount of accounts receivable that should be included in current assets?
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