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Chapter 8: Problem 7

Wesson Company uses the allowance method to record its expected credit losses. It estimates its losses at one percent of credit sales, which were \(\$ 750,000\) during the year. The Accounts Receivable balance was \(\$ 220,000\) and the Allowance for Doubtful Accounts had a credit balance of \(\$ 1,000\) at year-end. What amount is the debit to the Bad Debts Expense? a. \(\$ 7,500\) b. \(\$ 8,500\) c. \(\$ 6,500\) d. \(\$ 3,200\)

Short Answer

Expert verified
The debit to Bad Debts Expense is $7,500.

Step by step solution

01

Identify Credit Sales for the Year

Determine the total amount of credit sales for the year. As given, the credit sales for Wesson Company were $750,000.
02

Determine Estimated Bad Debts

Calculate the estimated bad debts based on the percentage of credit sales. Since the company estimates its losses at 1% of credit sales, you use the formula: \( \text{Estimated Bad Debts} = \text{Credit Sales} \times 0.01 \). Thus, \( 750,000 \times 0.01 = 7,500 \).
03

Determine Debit to Bad Debts Expense

In the allowance method, the estimated bad debts directly become the debit to Bad Debts Expense. Since we have already determined the estimated bad debts to be \(7,500 from credit sales, the debit amount to Bad Debts Expense is \( \\) 7,500 \).

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Key Concepts

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

Credit Sales
Credit sales refer to the transactions where goods or services are sold to customers but payment is deferred to a later date. These sales are crucial for businesses as they can significantly increase revenue by allowing more customers the flexibility to purchase.
However, with increased sales come the risks of some customers failing to pay their dues, resulting in bad debts. Companies, therefore, must balance between offering credit to boost sales and managing the risk of non-payment. Monitoring credit sales and their associated risks is an integral part of the company's financial practices.
Bad Debts Expense
Bad debts expense is recognized on a company's income statement as the amount expected to be uncollectible from previously recorded receivables. In the context of credit sales, companies acknowledge that not all customers will pay their debts.
This expense reflects the cost of offering credit and ensures accurate financial reporting. Companies often use historical data or industry standards to estimate their bad debts expense, which helps in reflecting the real financial condition of the business. One common technique to estimate this amount is by using a percentage of credit sales, as done by Wesson Company, ensuring the costs associated with credit sales are accounted for.
Accounts Receivable
Accounts receivable represents money that is owed to a company by its customers for goods or services delivered but not yet paid. This figure appears on the balance sheet as a current asset because it is expected to be converted into cash within a year.
Accounts receivable is crucial in assessing a company's liquidity and financial health. Efficient management of accounts receivable ensures there is enough cash flow for daily operations. Companies, therefore, regularly analyze their accounts receivable to ensure timely collection and to manage potential defaults effectively.
Allowance for Doubtful Accounts
Allowance for doubtful accounts is a contra-asset account that is used to estimate the portion of accounts receivable that might not be collected. This allowance reflects anticipated future losses from uncollectible accounts.
It offsets the accounts receivable on the balance sheet, providing a more realistic view of the expected cash inflows. Companies regularly adjust this allowance based on new information about credit sales and payment histories, ensuring that financial statements accurately portray potential risks. Regularly updating this account in response to changes in credit conditions supports effective financial planning and risk management.

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Most popular questions from this chapter

Recognizing Accounts Receivable On June 7, Pixer Co, sells \(\$ 1,500\) of merchandise to Jasmine Co. on account. Jasmine Co. pays for this merchandise on June 21 . a. Prepare the entry on Pixer's books to record the sale. b. Prepare the entry on Pixer's books to record the receipt of payment.

Recognizing Accounts Receivable On August 9, Gait Co. sells \(\$ 980\) of merchandise to Taylor Co. on account. Taylor Co. pays for this merchandise on September \(1 .\) a. Prepare the entry on Gait's books to record the sale. b. Prepare the entry on Gait's books to record the receipt of payment.

Credit Losses Based on Accounts Receivable At December 31, Mueller Company had a balance of \(\$ 409,000\) in its Accounts Receivable account and a credit balance of \(\$ 4,200\) in the Allowance for Doubtful Accounts account. The accounts receivable T-account consisted of \(\$ 414,000\) in debit balances and \(\$ 5,000\) in credit balances. The company aged its accounts as follows: In the past, the company has experienced credit losses as follows: one percent of current balances, five percent of balances \(0-60\) days past due, 18 percent of balances \(61-180\) days past due, and 30 percent of balances over six months past due. The company bases its allowance for doubtful accounts on an aging analysis of accounts receivable. Required a. Prepare the adjusting entry to record the allowance for doubtful accounts for the year. b. Show how Accounts Receivable (including the credit balances) and the Allowance for Doubtful Accounts would appear on the December 31 balance sheet.

Lite Company received a 90 day, six percent note receivable for \(\$ 10,000\) on December 1 . How much interest should be accrued on December 31 ? a. \(\$ 150\) b. \(\$ 90\) c. \(\$ 50\) d. \(\$ 25\)

Accounting for Credit Card Sales Carter \& Company pays a three percent credit card fee on all credit sales, and receives a cash deposit immediately following each credit card transaction. If credit sales for the company total \(\$ 30,000\) on January 15 , what journal entry should be recorded to recognize the receipt of cash and the credit card fee expense? a. Debit Cash \(\$ 29,100\); debit Credit Card Fee Expense \(\$ 900\). b. Debit Cash \(\$ 29,100\); credit Credit Card Fee Expense \(\$ 900\). c. Debit Cash \(\$ 30,900\); debit Credit Card Fee Expense \(\$ 900\). d. Debit Cash \(\$ 30,900\); credit Credit Card Fee Expense \(\$ 900\).
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