Question

Allowance Method of Accounting for Bad Debts—Comparison of the Two Approaches

Guzman Inc. had the following data available for 2017 (before making any adjustments):

Accounts receivable, 12/31/17	$324,200
Allowance for doubtful accounts	2,600
Net credit sales, 2017	842,000

Required:

1. Identify and analyze the adjustment to recognize bad debts under the following assumptions:
(a) bad debts expense is expected to be 2% of net credit sales for the year.

Activity
Accounts
Statement(s)

How does this entry affect the accounting equation?
If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign. Remember: if a contra account is increased, it will have the effect of decreasing the corresponding financial statement item.

Balance Sheet

Income Statement

Stockholders'

Net

Assets

=

Liabilities

+

Equity

Revenues

–

Expenses

=

Income

Bad Debts Expense

Allowance for Doubtful Accounts

(b) Guzman expects it will not be able to collect 6% of the balance in accounts receivable at year-end.

Activity
Accounts
Statement(s)

How does this entry affect the accounting equation?
If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign. Remember: if a contra account is increased, it will have the effect of decreasing the corresponding financial statement item.

Balance Sheet

Income Statement

Stockholders'

Net

Assets

=

Liabilities

+

Equity

Revenues

–

Expenses

=

Income

2. Assume instead that the balance in the allowance account is a negative $2,600. How will this affect your answers to part (1)?

(a) bad debts expense is expected to be 2% of net credit sales for the year.

Activity
Accounts
Statement(s)

How does this entry affect the accounting equation?
If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign. Remember: if a contra account is increased, it will have the effect of decreasing the corresponding financial statement item.

Balance Sheet

Income Statement

Stockholders'

Net

Assets

=

Liabilities

+

Equity

Revenues

–

Expenses

=

Income

(b) Guzman expects it will not be able to collect 6% of the balance in accounts receivable at year-end.

Activity
Accounts
Statement(s)

How does this entry affect the accounting equation?
If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign. Remember: if a contra account is increased, it will have the effect of decreasing the corresponding financial statement item.

Balance Sheet

Income Statement

Stockholders'

Net

Assets

=

Liabilities

+

Equity

Revenues

–

Expenses

=

Income

Answer 1

Accounts receivable, 12/31/17 Allowance for doubtful accounts Net credit sales, 2017 $ $ 324,200 2,600 842.000 1-a Bad debts expense is expected to be 2% of net credit sales In case of percentage on sales method "Bad debts expense" is recognised irrespective of balance in "allowance for doubtful accounts" Bad debts expense = Net credit sales * Percentage of bad debts = $ 842.000*2% $ 16,840 Balance in allowance for doubtful debts before adjustment $ 2,600 Credit General journal Bad debts expense Allowance for doubtful accounts Debit $ 16,840 $16.840 1-b Bad debts expense is expected to be 6% of accounts receivable In case of percentage on accounts receivable "Bad debts expense" is amount to be adjusted to closing balance of "allowance for doubtful accounts" Bad debts expense = accounts receivables * Percentage of bad debts = $ 324,200*6% $ 19,452 A Balance in allowance for doubtful debts before adjustment $ 2,600 B Balance to be created $ 16,852 A-B Debit Credit General journal Bad debts expense Allowance for doubtful accounts 16,852 $16.852

1-a Balance Sheet Income Statement Net Revenues - Expenses = Income Assets Stockholders' Equity = Liabilities Allowance for Doubtful Accounts Bad Debts Expense 16,840 (16,840) $ 16,840 $(16,840) 1-1 Balance Sheet Stockholders' Equity Income Statement Net Revenues – Expenses = Income Assets Liabilities + Allowance for Doubtful Accounts Bad Debts Expense $ 16,852 $ (16,852) $ 16,852 $(16,852)

2-a Bad debts expense is expected to be 2% of net credit sales In case of percentage on sales method "Bad debts expense" is recognised irrespective of balance in "allowance for doubtful accounts" Bad debts expense = Net credit sales * Percentage of bad debts = $ 842.000*2% $ 16,840 Balance in allowance for doubtful debts before adjustment $ 2,600 Credit General journal Bad debts expense Allowance for doubtful accounts Debit $ 16,840 $16,840 2-b Bad debts expense is expected to be 6% of accounts receivable In case of percentage on accounts receivable "Bad debts expense" is amount to be adjusted to closing balance of "allowance for doubtful accounts" Bad debts expense = accounts receivables * Percentage of bad debts = $ 324,200*6% $ 19,452 A Balance in allowance for doubtful debts before adjustment $ (2,600) B Balance to be created 22,052 A-B Credit General journal Bad debts expense Allowance for doubtful accounts Debit $ 22,052 $22,052

2-a Balance Sheet Income Statement Net Revenues - Expenses = Income Assets Stockholders' Equity = Liabilities Allowance for Doubtful Accounts Bad Debts Expense 16,840 (16,840) $ 16,840 $(16,840) 2-b Balance Sheet Stockholders' Equity Income Statement Net Revenues – Expenses = Income Assets Liabilities + Allowance for Doubtful Accounts Bad Debts Expense $ 22,052 $ (22,052) $ 22,052 $(22,052)