Question

Allowance Method Steinbrook Company, which has been in business for three years, makes all of its sales on account and does not offer cash discounts. The firm's credit sales, collections from custom- ers, and write-offs of uncollectible accounts for the three-year period are summarized as follows: Year Sales Collections Accounts Written Off 2015 $751,000 $733,000 864,000 938,000 $5,300 2016 876,000 975,000 6,200 6,500 2017 Required a. If Steinbrook Company used an allowance method of recognizing credit losses and provided for such losses at the rate of one percent of credit sales, what amounts of accounts receivable and the allowance for doubtful accounts should appear on the firm's balance sheet at the end of 2017? What total amount of bad debts expense should appear on the firm's income statement during the three-year period? b. Comment on the use of the one percent rate to provide for credit losses in part a.

b. Comment on the use of the one percent rate to provide for credit losses in part a.

Answer 1

a. If Steinbrook Company used an allowance method:

Allowance for Doubtful Accounts
2015
		Bad Debt Expense	$ 7,510
		End. bal.	7,510
2016
Accounts Written Off	6,200	Beg. bal.	7,510
		Bad Debt Expense	8,760
		End. bal.	10,070
2017
Accounts Written Off	6,500	Beg. bal.	10,070
		Bad Debt Expense	9,750
		End. bal.	13,320

	2015	2016	2017
Bad Debt Expense on Income Statement	$ 12,810	$ 8,760	$ 9,750

Steinbrook Company Balance Sheet ( Partial) December 31, 2017
ASSETS	$	$
Current Assets
Accounts Receivable	49,000
Less: Allowance for Doubtful Accounts	(13,320)
Accounts Receivable, net		35,680

B.  One of the risks of selling goods on credit is that not all payments may be collected. To factor in this uncertainty, companies create an allowance for credit losses.

The small allowance of 1 % for credit losses enables Steinbrook Company to take these anticipated losses into consideration in its financial statements to limit overstatement of potential income, and overstatement of asset. To avoid an account overstatement, a company will estimate how much of its receivables it expects will be delinquent. Not only this gives a fair view to the users of the financial statements, it also helps to set aside a small percentage of 1 % from profits in the year the sales revenue is recognized. This also helps the company to adhere to the matching principle of accounting.

The allowance is all the more necessary and meaningful since the company does not offer a cash discount.