Chapter 5, Problem 5.13E

Requirement 1:

To determine

To record: Each transaction using the allowance method.

Explanation of Solution

Allowance method:

It is a method for accounting bad debt expense, where uncollectible accounts receivables are estimated, and recorded at the end of particular period. Under this method, bad debts expenses are estimated and recorded prior to the occurrence of actual bad debt, in compliance with matching principle by using the allowance for bad debt account.

Journal entry for installing air conditioning systems on account:

Date	Account Title and Explanation		Debit($)	Credit($)
a.	Accounts receivable		190,000
		Service revenue		190,000
	(To record the services rendered on account)

Table (1)

Description:

Company BHA, has provided services on account, this increases accounts receivable and service revenue. Hence,

• An increase in accounts receivable (asset account) is debited with $190,000 and
• An increase in sales revenue (stockholders’ equity account) is credited with $190,000.

Journal entry for collecting cash from customers on account:

Date	Account Title and Explanation		Debit($)	Credit($)
b.	Cash		185,000
		Accounts receivable		185,000
	(To collect cash on account)

Table (2)

Description:

• An increase in cash (asset account) is debited with $185,000 and
• A decrease in accounts receivable (asset account) is credited with $185,000.

Journal entry at the end of 2015 for uncollectible accounts:

Date	Particulars		Debit	Credit
c.	Bad debt expense (1)		$4,650
		Allowance for uncollectible accounts		$4,650
	(To adjust the allowance for uncollectible accounts)

Table (3)

Description:

• An increase in bad debt expense (decrease in stockholders’ equity account) is debited with $4,650, and
• An increase in allowance for uncollectible accounts (contra asset account) is credited with $4,650.

Working notes:

To determine the balance of accounts receivable at the end of the year 2015, prepare T account for accounts receivable:

Accounts receivable
Opening Balance	$26,000	Cash	$185,000
Service revenue	$190,000
		Bal.	$31,000

Calculation of uncollectible accounts at the end of 2015:

$\begin{array}{c}\text{Uncollectible accounts}=\left[\begin{array}{l}\text{Balance of accounts receivable}\times \\ \text{ uncollectible accounts estimate}\end{array}\right]\\ =\$31,000\times 15\%\\ =\$4,650\end{array}$ (1)

Entry for the allowance for uncollectible accounts:

Date	Particulars		Debit	Credit
d.	Allowance for uncollectible accounts		8,000
		Accounts receivable		8,000
	(To record write-off actual bad debts)

Table (4)

Description:

• A decrease in allowance for uncollectible accounts (contra asset account) is debited with $8000 and,
• A decrease in accounts receivable accounts (asset account) is credited with $8,000.

Requirement 2:

To determine

To record: Each transaction using the direct write-off method.

Explanation of Solution

Direct write-off method:

This method does not make allowance or estimation for uncollectible accounts, instead this method directly write-off the actual uncollectible accounts by debiting bad debt expense and by crediting accounts receivable. Under this method, accounts would be written off only when the receivables from a customer remain uncollectible.

Journal entry for installing air conditioning systems on account:

Date	Account Title and Explanation		Debit($)	Credit($)
a.	Accounts receivable		190,000
		Service revenue		190,000
	(To record the services rendered on account)

Table (5)

Description:

Company BHA, has provided services on account, this increases accounts receivable and service revenue. Hence,

• An increase in accounts receivable (asset account) is debited with $190,000 and
• An increase in sales revenue (stockholders’ equity account) is credited with $190,000.

Journal entry for collecting cash from customers on account:

Date	Account Title and Explanation		Debit($)	Credit($)
b.	Cash		185,000
		Accounts receivable		185,000
	(To collect cash on account)

Table (6)

Description:

• An increase in cash (asset account) is debited with $185,000 and
• A decrease in accounts receivable (asset account) is credited with $185,000.

c. No entry required

Description:

Direct write-off method:

Direct write-off method reduces accounts receivable and records bad debts at the time of account receivable is proved uncollectible and it has no adjustment because Company BHA records the adjustment at the end of 2015 which is uncollectible.

Direct write off method records the adjustment until those bad debts are actually uncollectible.

Journal entry for the year 2016:

Date	Account Title and Explanation		Debit($)	Credit($)
d.	Bad debts expenses		8,000
		Accounts receivable		8,000
	(To record the actual bad debts)

Table (7)

Description:

Journal entry for the year 2016:

• An increase in the bad debts ( decrease in stock holder’s equity) it is debited with $8,000 and
• A decrease in the accounts receivable (asset) it is credited with $8,000.

Requirement 3:

To determine

To Calculate: The difference in net income (before taxes) in 2015 and 2016 between the two methods.

Explanation of Solution

The difference in net income (before taxes) in 2015 and 2016 between the two methods is:

Bad debt expense	Allowance method	Direct write-off method
2015	$ 4,650	$ 0
2016	$ 0	$ 8,000

Table (8)

Description:

• Under allowance method bad debts (2015) are recorded as $4,650, so net income would be lowered by $4,650 under allowance method when it is compared to the direct write-off method.
• Under direct write-off method bad debts (2016) are recorded as $8,000 so net income would be lowered by $8,000 under direct write-off method when it is compared to the allowance method.
• The difference in amount in both the years indicates that bad debts estimated in 2015 did not occur in 2016.