Question

Exercise 7-7A Effect of recognizing uncollectible accounts on the financial statements: percent of receivables allowance method LO 7-2

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Leach Inc. experienced the following events for the first two years of its operations:

Year 1:

1. Issued $27,000 of common stock for cash.
2. Provided $96,700 of services on account.
3. Provided $53,000 of services and received cash.
4. Collected $86,000 cash from accounts receivable.
5. Paid $55,000 of salaries expense for the year.
6. Adjusted the accounting records to reflect uncollectible accounts expense for the year. Leach estimates that 5 percent of the ending accounts receivable balance will be uncollectible.
7. Closed the revenue account.
8. Closed the expense account.

Year 2:

1. Wrote off an uncollectible account for $820.
2. Provided $105,000 of services on account.
3. Provided $49,000 of services and collected cash.
4. Collected $98,000 cash from accounts receivable.
5. Paid $82,000 of salaries expense for the year.
6. Adjusted the accounts to reflect uncollectible accounts expense for the year. Leach estimates that 5 percent of the ending accounts receivable balance will be uncollectible.

Answer 1

Year 1:

Calculation of Accounts Receivable Ending Balance for Year 1: Amount Sales $ 96,700 Less: Collections $ 86,000 Ending Balance $ 10,700 Bad Debt Expense $ 535 Calculation (10,700 X 5%) Journal Entry for Adjustment: Account Title Debit Credit Bad Debt Expense $ 535 Allowance for Doubtful Debts $ 535 (To record bad debt expense for the year) Journal Entry for Closing Revenue Account: Account Title Debit Credit Service Revenue (96,700 +53,000) $ 149,700 Income Summary $ 149,700 (To record closing entry for revenue) Journal Entry for Closing Expense Account: Account Title Debit Credit Income Summary $ 55,535 Bad Debt Expense $ 535 Salaries expense $ 55,000 (To record closing entry for expenses)

Year 2:

Calculation of Accounts Receivable Ending Balance for Year 2: Amount Opening Balance $ 10,700 Add: Sales $ 105,000 Less: Collections $ 98,000 Less: Write Off $ 820 Ending Balance $ 16,880 Bad Debt Expense $ 844 Calculation (10,700 X 5%) Journal Entry for Adjustment: Debit Credit Bad Debt Expense $ 844 Allowance for Doubtful Debts $ 844 (To record bad debt expense for the year) Closing Balance of Allowance for Doubtful Debts before adjustment = Opening Balance (credit) - Write Off Closing Balance of Allowance for Doubtful Debts before adjustment = $535 - $820 = $285 This is a debit balance, as write off is greater then the opening balance. Hence, when we calculate the bad debt expense, it will be added to it. Bad Debt Expense = (Year End Accounts Receivable x Bad Debts %) + Balance in Allowance for Doubtful Debts Bad Debt Expense = ($16,880 X 5%) + $285 Bad Debt Expense = $844 + $285 Bad Debt Expense = $1,129