Chapter 8, Problem 1CC

Accounting for Receivables and Uncollectible Accounts

The following transactions occurred over the months of September to December at Nicole’s Getaway Spa (NGS).

September	Sold spa merchandise to Ashley Welch Beauty for $1,800 on account; the cost of these goods to NGS was $900.
October	Sold merchandise to Kelly Fast Nail Gallery for $450 on account; the cost of these goods to NGS was $200.
November	Sold merchandise to Raea Gooding Wellness for $300 on account; the cost of these goods to NGS was $ 190.
December	Received $1,200 from Ashley Welch Beauty for payment on its account.

Required:

1. 1. Prepare journal entries for each of the transactions. Assume a perpetual inventory system.
2. 2. Estimate the Allowance for Doubtful Accounts required at December 31, assuming the only receivables outstanding at December 31 arise from the transactions listed above. NGS uses the aging of accounts receivable method with the following uncollectible rates: one month. 2%; two months, 5%; three months, 20%; more than three months, 35%.
3. 3. The Allowance for Doubtful Accounts balance was $47 (credit) before the end-of-period adjusting entry is made. Prepare the journal entry to account for the Bad Debt Expense.
4. 4. Assume the end of the previous year showed net accounts receivable of $800, and net sales for the current year are $9,000. Calculate the accounts receivable turnover ratio (round to one decimal place).
5. 5. Audrey’s Mineral Spa has an accounts receivable turnover ratio of 12.0 times. How does NGS compare to this competitor?

To determine

To prepare: The journal entries for each of the transactions, using perpetual inventory system.

Explanation of Solution

Perpetual Inventory System:

It is the inventory system that maintains the detailed records of every inventory transactions related to purchases and sales on a continuous basis. It shows the exact on-hand-inventory at any point of time.

Prepare the journal entry.

Date	Account titles and explanation	Debit	Credit
September	Accounts receivable	$1,800
	Sales revenue		$1,800
	(To record the sale of merchandise on account)
September	Cost of goods sold	$900
	Inventory		$900
	(To record the cost of goods sold)
October	Accounts receivable	$450
	Sales revenue		$450
	(To record the sale of merchandise on account)
October	Cost of goods sold	$200
	Inventory		$200
	(To record the cost of goods sold)
November	Accounts receivable	$300
	Sales revenue		$300
	(To record the sale of merchandise on account)
November	Cost of goods sold	$190
	Inventory		$190
	(To record the cost of goods sold)
December	Cash	$1,200
	Accounts receivable		$1,200
	(To record the collection of cash on account)

Table (1)

To determine

To estimate: The allowance for doubtful accounts required at December 31.

Explanation of Solution

Aging of receivables method:

A method of determining the estimated uncollectible receivables based on the age of individual accounts receivable is known as aging of receivables method. Amount of accounts receivables of different age and its respective uncollectible percentage are multiplied, to determine the estimated uncollectible receivables for each age group of receivable.

Prepare the aged list of customer accounts at December 31 are as follows:

		Unpaid since
Customer	Total Balance	2 months	3 months	Greater than 3 months
AW Beauty	$600			$600
KFN Gallery	$450		$450
RG Wellness	$300	$300
Total	$1,350	$300	$450	$600

Table (2)

Prepare a schedule to estimate the year-end balance for allowance for doubtful accounts.

	Number of months unpaid
	Total	2 months	3 months	Over 3 months
Accounts Receivable	$1,350	$300	$450	$600
Estimated Uncollectible (%)		$\times$5%	$\times$ 20%	$\times$35%
Estimated Uncollectible ($)	$315	$15	$90	$210

Table (3)

Thus, the estimated allowance for doubtful accounts required at December 31 is $315.

Conclusion

Thus, the estimated allowance for doubtful accounts required at December 31 is $315.

To determine

To prepare: The journal entry to account for the bad debt expenses.

Explanation of Solution

Aging of receivables method:

A method of determining the estimated uncollectible receivables, based on the age of individual accounts receivable is known as aging of receivables method. Under this method estimated uncollectible accounts would be treated as a target allowance balance.

Determine the amount of bad debt expense for the year.

$\begin{array}{c}\text{Bad debt expense = }\left[\begin{array}{l}\text{Estimated ending balance in allowance for doubtful accounts}\\ -\text{Credit balance in allowance for doubtful accounts}\\ \text{before adjustment}\end{array}\right]\\ =\left[\$315-\text{\$47}\right]\\ =\$268\end{array}$

Allowance for doubtful accounts (contra asset account) normal balance is a credit balance. It is also given that Company N’s unadjusted balance in Allowance for doubtful accounts is a credit of $47, and it is also given that allowance for doubtful accounts ending balance should be $315, which is estimated under the aging of accounts receivable method. Hence, to bring the allowance for doubtful account balance from a credit of $47 to a credit of $315, Company N is required to recognize bad debt expense of $268 by increasing its bad debt expense and allowance for doubtful accounts by $268.

Prepare the adjusting journal entry to record the bad debt expense, assume Company N uses aging of receivables method.

Date	Account titles and explanation	Debit	Credit
	Bad debt expense	$268
	Allowance for doubtful accounts		$268
	(To record the bad debt expense)

Table (4)

To determine

To calculate: The receivables turnover ratio.

Explanation of Solution

Accounts receivable turnover ratio:

Accounts receivable turnover is a liquidity measure of accounts receivable in times, which is calculated by dividing the net credit sales by the average amount of net accounts receivables. In simple, it indicates the number of times the average amount of net accounts receivables has been collected during a particular period.

Average collection period:

Average collection period indicates the number of days taken by a business to collect its outstanding amount of accounts receivable on an average.

Calculate accounts receivables turnover ratio:

$\begin{array}{c}\begin{array}{l}\text{Accounts receivable}\\ \text{turnover ratio}\end{array}\}=\frac{\text{Net sales}}{\text{Average net accounts receivable}}\\ =\frac{\text{Net sales}}{\frac{\left(\begin{array}{l}\text{Beginning net accounts receivable }+\\ \text{Ending net accounts receivable}\end{array}\right)}{2}}\\ =\frac{\$9,000}{\frac{\left(\$800+\text{\$1,035}\right)}{2}}\\ =\text{9}\text{.8}\text{times}\end{array}$

Thus, the accounts receivable turnover ratio of Company N is 9.8 times.

Working note:

Calculate the ending net accounts receivable.

Particulars	Amount
Accounts receivable	$1,350
Less: Allowance for doubtful accounts	($315)
Ending net accounts receivable	$1,035

Table (5)

Conclusion

Accounts receivable turnover ratio of Company N is 9.8 times.

To determine

To compare: The accounts receivable turnover ratio of Company N with its competitor of Company A.

Explanation of Solution

Accounts receivable turnover ratio of Company N is 9.8 times andthe accounts receivable turnover ratio of Company A is 12.0 times.

A company which has higher receivables turnover ratio is considered as the best company in converting its receivables to cash.

Now comparison of both companies accounts receivable turnover ratio shows that Company N is slower in collecting its receivable from its customers than its competitor Company A.