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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

Effect of doubtful accounts on net income

Using the data in Exercise 9-15, assume that during the second year of operations, Mack’s Plumbing Supply Co. had sales of $4,100,000, wrote off $34,000 of accounts as uncollectible using the direct write-off method, and reported net income of $600,000.

  1. a. Determine what net income would have been in the second year if the allowance method (using 1% of sales) had been used in both the first and second years.
  2. b. Determine what the balance of the allowance for doubtful accounts would have been at the end of the second year if the allowance method had been used in both the first and second years. Hint: Use an Allowance for Doubtful Accounts T account.

(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.

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. This method debit allowance for doubtful accounts and credits accounts receivable to write-off the uncollectible accounts.

To determine: The amount of net income would have been in the second year, if Company MPS estimated that 1% of sales would be uncollectible, instead of using direct write off method.

Explanation

Calculate net income under allowance method.

Particulars Amount Amount
Net income under direct method   $600,000
    Bad debt expense under direct method $34,000  

    Bad debt expense under allowance method

    ($4,100,000×1%)

$41,000  
Less: Increase in bad debt expense under allowance method   $7,000

(b)

To determine
The allowance for doubtful accounts balance would have been at the end of year 2, if Company MPS uses allowance method instead of direct method in both of its year 1 and 2.

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