Question

The credit manager of Montour Fuel has gathered the following information about the company’s accounts receivable and credit losses during the current year:

Net credit sales for the year        $8,000,000
Accounts receivable at year-end        1,750,000
Uncollectible accounts receivable:       
Actually written off during the year    $96,000   
Estimated portion of year-end receivables expected to prove uncollectible (per aging schedule)    84,000    180,000

Prepare one journal entry summarizing the recognition of uncollectible accounts expense for the entire year under each of the following independent assumptions.

   1.) Uncollectible accounts expense is estimated at an amount equal to 2.5 percent of net credit sales.

2.) Uncollectible accounts expense is recognized by adjusting the balance in the Allowance for Doubtful Accounts to the amount indicated in the year-end aging schedule. The balance in the allowance account at the beginning of the current year was $25,000. (Consider the effect of the write-offs during the year on the balance in the Allowance for Doubtful Accounts.)

3.) The company uses the direct write-off method of accounting for uncollectible accounts.

4.)    Which of the three methods gives investors and creditors the most accurate assessment of a company’s liquidity? Defend your answer.

Answer 1

1) Uncomfortable accounts expense= 2.5% * $ 8,000,000

= $ 200,000

	Particular	Debit	Credit
	Bad debts Expense	$ 200,000
	To Allowance for doubtful Accounts		$ 104,000
	To Accounts Receivable		$ 96,000
	( To record uncollectible accounts expense)

2)

Particular	Debit	Credit
Bad debts Expense	$ 155,000
To Allowances of Doubtful Accounts		$ 59,000
To Account Receivable		$ 96,000
( To record uncollectible accounts expense)

3)

Particular	Debit	Credit
Bad Debts Expense	$ 96,000
To Accounts Receivable		$ 96,000
( To record uncollectible accounts expense)

4) It  would be either (a) or (b) but not (c) as (c) violates the matching principle. I would prefer (b) since that implies that someone has gone through the AR listing and has determined which debtor is likely to be Uncollectible. (a) is harder to justify as it's a flat rate of 2.5%, which can be arbitrary.