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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Entries for bad debt expense under the direct write-off and allowance methods

The following selected transactions were taken from the records of Shipway Company for the first year of its operations ending December 31:

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  1. a. Journalize the transactions under the direct write-off method.
  2. b. Journalize the transactions under the allowance method. Shipway Company uses the percent of credit sales method of estimating uncollectible accounts expense. Based on past history and industry averages, ¾% of credit sales are expected to be uncollectible. Shipway Company recorded $3,778,000 of credit sales during the year.
  3. c. How much higher (lower) would Shipway Company’s net income have been under the direct write-off method than under the allowance method?

(a)

To determine

Bad debt expense:

Bad debt expense is an expense account. The amounts of loss incurred from extending credit to the customers are recorded as bad debt expense. In other words, the estimated uncollectible accounts receivable are known as bad debt expense.

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.

To journalize: The transactions under direct write off method.

Explanation

Journalize the transactions of Company S under direct write off method.

Date Particulars Debit Credit
April 13 Bad debt expense $8,450  
       Account receivable – Person S   $8,450
  (To record the write-off of uncollectible account receivable )    
 
May 15 Cash $500  
  Bad debt expense $6,600  
       Account receivable – Person DP   $7,100
  (To record the cash collection and write-off of remaining uncollectible account receivable )    
 
July 27 Accounts receivable – Person S $8,450  
        Bad debt expense   $8,450
  (The reinstate the account of Person S)    
 
July 27 Cash $8,450  
        Accounts receivable – Person S   $8,450
  (To record collection of cash on account)    
 
December 31 Bad debt expense $13,510  
     Account receivable – Person PC   $2,225
       Account receivable – Person DD   $3,550
       Account receivable – Person TG   $4,770
       Account receivable – Person EK   $1,275
       Account receivable – Person MR   $1,690
  (To record the write-off of uncollectible account receivable )    
 
December 31 No entry is required    

Table (1)

Description:

For April 13:

To record this write-off of uncollectible receivables under direct write-off method, bad debt expense must be recognized as well as increased, and accounts receivable must be decreased by $8,450...

(b)

To determine

Allowance method:

It is a method for accounting bad debt expense, where amount of 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 doubtful account.

Two methods to estimate uncollectible accounts under allowance method are:

  • Percentage of sales method, and
  • Analysis of receivables method.

Percentage of sales method:

Credit sales are recorded by debiting (increasing) accounts receivable account. The bad debts is a loss incurred out of credit sales, hence uncollectible accounts can be estimated as a percentage of credit sales or total sales.

It is a method of estimating the bad debts (expected loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of net credit sale (or total sales) for a specific period. Under percentage of sales method, estimated bad debts would be treated as a bad debt expense of the particular period.

To journalize: The transactions under allowance method (Percentage of credit sales method).

(c)

To determine
Whether net income of Company S is higher or lower under the direct-write off method than allowance method.

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