Question

Problem 7-3 (Part Level Submission)

Pearl Corporation operates in an industry that has a high rate of bad debts. Before any year-end adjustments, the balance in Pearl's Accounts Receivable account was $595,600 and Allowance for Doubtful Accounts had a credit balance of $40,350. The year-end balance reported in the balance sheet for Allowance for Doubtful Accounts will be based on the aging schedule shown below.

Days Account Outstanding		Amount			Probability of Collection
Less than 16 days		$314,500			0.97
Between 16 and 30 days		119,900			0.90
Between 31 and 45 days		84,800			0.85
Between 46 and 60 days		43,000			0.82
Between 61 and 75 days		19,800			0.53
Over 75 days		13,600			0.00

Assume that accounts with a zero percent chance of collection are intended to be written off.

Show how accounts receivable would be presented on the balance sheet.

PEARL CORPORATION Balance Sheet (Partial)

Answer 1

OVERVIEW: As per GAAP, whenever a sale is incurred the same will be recognised in the books of accounts irrespective of the fact whether the same has been realised in cash or not. Hence, Accounts receivable account is created. Now Pearl Corporation operates in an industry that has a high rate of bad debts. So it implies that out of all the sales recognised in this year, it isn't necessary that everything will realise. So, in order to report as per the matching principle of accounts, the concept of creating provision for bad debts was resorted to, wherein, if we are certain that a portion of bad debts would not be realised then we reduce the credit balance of profit and loss account for the same year in which sales have been made and increase the provision for bad debts for similar amount to match the expenses incurred against the income earned in the very same year.

Facts of the case:

In the given case, accounts with a zero percent chance of collection are intended to be written off. Therefore we will reduce the accounts receivable account as well as provision for bad debts account by $13,600 at the year end. Thus the journal entry for the same is given as follows:

Provision for bad debts a/c....Dr 13,600

To Accounts receivable a/c 13,600

Thus, the balance of Accounts receivable account after year end adjustment = $595600- $13600= $ 582000

Thus, the balance of Provision for bad debts account after year end adjustment = $40350- $13600= $ 26750

Extract of balance sheet:

Thus the balance sheet after the above mentioned year adjustment will be presented as follows: