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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

Estimate uncollectible accounts

For several years, Xtreme Co.’s sales have been on a “cash only” basis. On January 1, 20Y4, however, Xtreme Co. began offering credit on terms of n/ 30. The amount of the adjusting entry to record the estimated uncollectible receivables at the end of each year has been ½ of 1% of credit sales, which is the rate reported as the average for the industry. Credit sales and the year-end credit balances in Allowance for Doubtful Accounts for the past four years are as follows:

Year Credit Sales Allowance for Doubtful Accounts
20Y4 $4,000,000 $ 5,000
20Y5 4,400,000 8,250
20Y6 4,800,000 10,200
20Y7 5,100,000 14,400

Laurie Jones, president of Xtreme Co., is concerned that the method used to account for and write off uncollectible receivables is unsatisfactory. She has asked for your advice in the analysis of past operations in this area and for recommendations for change.

  1. 1. Determine the amount of (a) the addition to Allowance for Doubtful Accounts and (b) the accounts written off for each of the four years.
  2. 2. a.    Advise Laurie Jones as to whether the estimate of ½ of 1% of credit sales appears reasonable.

b.    Assume that after discussing (a) with Laurie Jones, she asked you what action might be taken to determine what the balance of Allowance for Doubtful Accounts should be at December 31, 20Y7, and what possible changes, if any, you might recommend in accounting for uncollectible receivables. How would you respond?

(1)

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.

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 determine: the amount of (a) the addition to allowance for doubtful accounts and (b) the accounts written off for each of the four years.

Explanation

(a)

Determine the amount of addition to allowance for doubtful accounts.

Year Addition to allowance for doubtful accounts
20Y4 $20,000 ($4,000,000×12×1%)
20Y5 $22,000 ($4,400,000×12×1%)
20Y6 $24,000 ($4,800,000×12×1%)
20Y7 $14,400 ($5,100,000×12×1%)

Hence, the amount of addition to allowance for doubtful accounts in 20Y4, 20Y5, 20Y6, 20Y7 is $20,000, $22,000, $24,000, and $14,400 respectively.

(b)

Determine the amount of accounts written off in year 20Y4.

Amount of accountswritten off in year 20Y4} = [Addition to allowance for doubtful accounts Credit balance at the end of year 20Y4]=$20,000$5,000=$15,000

Determine the amount of accounts written off in year 20Y5

(2) (a)

To determine

To advise: Person LJ, whether the estimate of ½ of 1% of credit sales appears reasonable.

(2) (b)

To determine

To discuss: The action, which is required to determine the required balance in allowance for doubtful accounts by December 31, 20Y7, and suggest the possible changes for the recommended accounting for  uncollectible receivables.

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