Chapter 5, Problem 83APSA

Bad Debt Expense: Percentage of Credit Sales Method

The Glass House, a glass and china store, sells nearly half its merchandise on credit. During the past 4 years, the following data were developed for credit sales and losses from uncollectible accounts:

Required:

1. Calculate the loss rate for each year from 2016 through 2018. ( Note: Round answers to three decimal places.)

2. Determine whether there appears to be a significant change in the loss rate over time.

3. CONCEPTUAL CONNECTION If credit sales for 2020 are $400,000, determine what loss rate you would recommend to estimate bad debts. ( Note: Round answers to three decimal places.)

4. Using the rate you recommend, record bad debt expense for 2020.

5. CONCEPTUAL CONNECTION Assume that the increase in The Glass House’s sales in

2020 was largely due to granting credit to customers who would have been denied credit in previous years. How would this change your answer to Requirement 4? Describe a legitimate business reason why The Glass House would adopt more lenient credit terms.

6. CONCEPTUAL CONNECTION Using the data from 2016 through 2019, estimate the increase in income from operations in total for those 4 years assuming (a) the average gross margin is 25% and (b) 50% of the sales would have been lost if no credit was granted.

To determine

(a)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

To calculate:

The loss rate for each year from $2016$.

Answer to Problem 83APSA

The loss Rate over the period is:

Year of Sales

Loss Rate Percentage
$2016$	$6.40\%$
$2017$	$6.584\%$
$2018$	$6.267\%$
$2019$	$8.159\%$

Explanation of Solution

The Glass House has a glass store which sells on credit. The data of past four years showing its credit sales and losses from uncollectible accounts are as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$
$2016$	$1,97,000$	$12,608$
$2017$	$2,02,000$	$13,299$
$2018$	$2,12,000$	$13,285$
$2019$	$2,73,000$	$22,274$
Total	$8,84,000$	$61,466$

This is given in the question.

The loss rate from uncollectible accounts for the Glass House is as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$	Loss Rate Percentage $(\ast )$
$2016$	$1,97,000$	$12,608$	$6.40\%$
$2017$	$2,02,000$	$13,299$	$6.584\%$
$2018$	$2,12,000$	$13,285$	$6.267\%$
$2019$	$2,73,000$	$22,274$	$8.159\%$
Total	$8,84,000$	$61,466$

$(\ast )$ The computation of loss rate from uncollectible accounts should be done by following formula:

$\text{Loss Rate}=\frac{\text{Uncollectible Accounts}}{\text{Net Credit Sales}}\times 100$.

To determine

(b)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

To calculate:

The significant change in the loss rate.

Answer to Problem 83APSA

The significant change is observed in the year $2019$ i.e. increased to $8.159\%$ which is highest as compared to other years.

Explanation of Solution

The Glass House has a glass store which sells on credit. The data of past four years showing its credit sales and losses from uncollectible accounts are as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$
$2016$	$1,97,000$	$12,608$
$2017$	$2,02,000$	$13,299$
$2018$	$2,12,000$	$13,285$
$2019$	$2,73,000$	$22,274$

This is given in the question.

The changes in the loss rates over the period for the Glass House are as follows:

Year of Sales

Loss Rate Percentage	Increase or Decrease in the Loss Rate over the period
	$\left(\text{a}\right)$	$\left(\text{b}\right)=\text{ Current year}÷\text{Base year of }\left(\text{a}\right)$	$\left(\text{c}\right)=\text{Current year}-\text{Base year}$
$2016$	$6.40\%$	$100.00\%$	$-$
$2017$	$6.584\%$	$102.875\%$	$2.875\%$
$2018$	$6.267\%$	$97.922\%$	$-2.078\%$
$2019$	$8.159\%$	$127.484\%$	$27.484\%$
NOTE: The Base Year in this is taken to be    $2016$

To determine

(c)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

To calculate:

The loss rate for estimating the bad debt for $2020$.

Answer to Problem 83APSA

The loss rate for estimating the bad debt in the year $2020$ is $7.048\%$.

Explanation of Solution

The Glass House has a glass store which sells on credit. The data of past four years showing its credit sales and losses from uncollectible accounts are as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$
$2016$	$1,97,000$	$12,608$
$2017$	$2,02,000$	$13,299$
$2018$	$2,12,000$	$13,285$
$2019$	$2,73,000$	$22,274$

This is given in the question.

The loss rate for estimating the bad debt in the year $2020$ for the Glass House is as follows:

Year

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$	Loss Rate Percentage	Probability of Loss	Weighted Average of Loss
	$\left(\text{a}\right)$	$\left(\text{b}\right)$	$\left(\text{c}\right)=\left(\text{b}\right)÷\left(\text{a}\right)$	$\left(\text{d}\right)=\left(\text{b}\right)÷\text{total of}\left(\text{b}\right)$	$\left(\text{e}\right)=\left(\text{c}\right)\times \left(\text{d}\right)$
$2016$	$1,97,000$	$12,608$	$6.40\%$	$20.51\%$	$1.313\%$
$2017$	$2,02,000$	$13,299$	$6.584\%$	$21.64\%$	$1.424\%$
$2018$	$2,12,000$	$13,285$	$6.267\%$	$21.61\%$	$1.354\%$
$2019$	$2,73,000$	$22,274$	$8.159\%$	$36.24\%$	$2.957\%$
Total	$8,84,000$	$61,466$			$7.048\%$

To determine

(d)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

To calculate:

The bad debt expense for $2020$ and the journal entry for recording the same.

Answer to Problem 83APSA

The bad debt expense for $2020$ is $\$28,192$ and the journal entry for recording the bad debt has been provided properly.

Explanation of Solution

The Glass House has a glass store which sells on credit. The data of past four years showing its credit sales and losses from uncollectible accounts are as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$
$2016$	$1,97,000$	$12,608$
$2017$	$2,02,000$	$13,299$
$2018$	$2,12,000$	$13,285$
$2019$	$2,73,000$	$22,274$

This is given in the question.

The credit sales given in the question is $\$4,00,000$ and the percentage of bad debts calculated on weighted average on the sales is $7.084\%$.

So, the bad debt expense to be recognised:

$\begin{array}{c}\text{Bad Debt Expense}=\text{Sales amount}\times \text{Percentage of bad debt}\\ =\$4,00,000\times 7.084\%\\ =\$28,192\end{array}$

The journal entry for the Glass House is as follows:

Date	Particulars	Debit ($)	Credit ($)
	Bad debt expense……… Allowance for Doubtful accounts.………(Record the entry of bad debt expense)	$28,192$	$28,192$

To determine

(e)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

The reason for adopting more lenient credit terms by the Glass House and its effect on the bad debt expense.

Answer to Problem 83APSA

The reasonable business reason for adopting the more lenient credit terms is that the business will increase their sales and revenue through this behaviour. The effect on bad debt will be that the bad debt will increase from this leniency.

Explanation of Solution

The leniency in the credit terms by the Glass House will increase the bad debt from $7.084\%$ to more than that. As the credit sales will be increased form earlier and this will also increase the expense of bad debt. The benefit of this behaviour to the company is that they can increase the sales of the business by offering such terms for credit sales. This will help in incremental revenues and profits.

To determine

(f)

Credit Sales Method:

The method named percentage of credit sales method is the method in which the bad debts are computed on the basis of percentage of sales.

Uncollectible accounts:

These are those accounts which reflect that amount of credit sales which is not to be collected i.e. bad debts.

To calculate:

The increase in the operating income over those $4$ years assuming gross profit is $25\%$ and the sales of $50\%$ will be lost due to no credit policy.

Answer to Problem 83APSA

The incremental in the operating income is $\$49,034$.

Explanation of Solution

The Glass House has a glass store which sells on credit. The data of past four years showing its credit sales and losses from uncollectible accounts are as follows:

Year of Sales

Credit Sales $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$
$2016$	$1,97,000$	$12,608$
$2017$	$2,02,000$	$13,299$
$2018$	$2,12,000$	$13,285$
$2019$	$2,73,000$	$22,274$

This is given in the question.

The increase in the income of the operations for the Glass House is as follows:

Year

Credit Sales $\left(\$\right)$	$50\%$ of Sales would have been lost due to no credit granted    $\left(\$\right)$	Gross Profit $\left(\$\right)$	Losses from Uncollectible Accounts $\left(\$\right)$	Increase in Operation Income $\left(\$\right)$
	$\left(\text{a}\right)$	$\left(\text{b}\right)=50\%\text{ of }\left(\text{a}\right)$	$\left(\text{c}\right)=\left(\text{b}\right)\times 25\%$	$\left(\text{d}\right)$	$\left(\text{e}\right)=\left(\text{d}\right)-\left(\text{c}\right)$
$2016$	$1,97,000$	$98,500$	$24,625$	$12,608$	$12,017$
$2017$	$2,02,000$	$1,01,000$	$25,250$	$13,299$	$11,951$
$2018$	$2,12,000$	$1,06,000$	$26,500$	$13,285$	$13,215$
$2019$	$2,73,000$	$1,36,500$	$34,125$	$22,274$	$11,851$
Total	$8,84,000$	$4,42,000$	$1,10,500$	$61,466$	$49,034$

Thus, the increase in the operation income is $\$49,034$.