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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Allowance for Bad Accounts Installment Jewelry Company has been in business for 5 years but has never had its financial statements audited. Engaged to audit them for 2019, you find that the company’s balance sheet carries no allowance for bad accounts. Bad accounts have been expensed as written-off and recoveries credited to income as collected. The company’s policy is to write off at December 31 of each year those accounts on which no collections have been received for three months. The installment contracts generally are for 2 years.

On your recommendation, the company agrees to revise its accounts for 2019 to give effect to bad account treatment on the allowance basis. The allowance is to be based on a percentage of credit sales that is derived from the experience of prior years. Statistics for the past 5 years are shown in the following table:

Chapter 6, Problem 4P, Allowance for Bad Accounts Installment Jewelry Company has been in business for 5 years but has , example  1

Chapter 6, Problem 4P, Allowance for Bad Accounts Installment Jewelry Company has been in business for 5 years but has , example  2

Required:

Prepare the adjusting journal entry or entries with appropriate explanations to set up the Allowance for Bad Accounts. (Support each item with organized computations; income tax implications should be ignored.)

To determine

Prepare the necessary adjusting entries with the proper explanation to set the allowance for doubtful accounts.

Explanation

Allowance for Doubtful Accounts:

This is a contra asset account to the Accounts Receivables account that reduces the asset balance, and report the net realizable accounts receivable value on the balance sheet. Allowance for Doubtful Accounts indicates the amount of receivables that are expected to remain uncollectible.

Prepare the necessary adjusting entries with the proper explanation to set the allowance for doubtful accounts

DateAccount Titles and explanationDebit ($)Credit ($)
 Bad debts recovered 600 
 Bad debt expense7,100 
      Allowance for doubtful accounts (3) 7,700
 (To record the bad debts recovered)  

Table (1)

  • Bad debt recovered is an asset and there is an increase in the value of an asset. Hence, debit the bad debts recovered by $600.
  • Bad debt expense is a component of stockholder’s equity and there is an increase in the value of expense. Hence, debit the bad debt expense by $7,100.
  • Allowance for doubtful accounts is a contra asset and there is a decrease in the value of asset. Hence, credit the allowance for doubtful accounts by $7,700.

Working note:

(1)  Calculate the bad debts expense for 2019 by suing the data of three years (2015 -2017):

Year

Credit sales

(A)

Bad Accounts

(B)

Recoveries

(C)

Net bad accounts

(D) =(BC)

Percent  of sales

E = DA×100

2015$100,000.00$2,550.00$100.00$2,450.002.45
2016$250,000.00$6,200.00$400

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