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Estimating Bad Debts - Financial Accounting

  1. During the year, a company wrote off a $5,000 account receivable. Later, the customer's financial situation improved, and the company recovered the entire $5,000 in cash. What is the net effect of the two journal entries required to record the recovery on the balance of the Allowance for Doubtful Accounts before any year-end adjustment for bad debt expense?
    Answer: A net increase of $5,000. Recording the recovery of a previously written-off account requires two entries. First, the write-off is reversed: Debit Accounts Receivable $5,000, Credit Allowance for Doubtful Accounts $5,000. This entry increases the allowance account balance. Second, the cash collection is recorded: Debit Cash $5,000, Credit Accounts Receivable $5,000. This second entry does not affect the allowance account. Therefore, the net effect of the recovery process on the allowance account is a $5,000 increase (credit).
  2. Meridian Company uses different methods to estimate bad debts for different purposes. For tax reporting, they use direct write-off. For financial reporting, they use aging of receivables, which indicates a required allowance of $45,000. For internal management reporting, they use 3% of credit sales ($900,000 for the year). The current allowance balance is $8,000 credit. What amount should be reported as bad debt expense on the financial statements if Meridian follows GAAP?
    Answer: $37,000 Under GAAP, the aging method requires adjusting the allowance account to the calculated balance. Required balance is $45,000, current balance is $8,000 credit, so the adjustment (bad debt expense) is $45,000 - $8,000 = $37,000. Choice A uses the percent of sales method incorrectly ($900,000 × 3% = $27,000). Choice C uses the total required allowance rather than the adjustment needed. Choice D incorrectly adds the required balance and current balance.
  3. A company uses the percentage of sales method to estimate bad debts. At the start of the year, the Allowance for Doubtful Accounts had a credit balance of $8,000. During the year, the company generated $500,000 in credit sales and wrote off $7,000 of specific uncollectible accounts. If the company's estimate for bad debts is 2% of credit sales, what is the ending balance in the Allowance for Doubtful Accounts at year-end?
    Answer: $11,000 The calculation requires three steps. First, calculate the Bad Debt Expense for the year: $500,000 (Credit Sales) × 2% = $10,000. Second, calculate the ending balance in the allowance account using the formula: Beginning Balance + Bad Debt Expense - Write-offs = Ending Balance. So, $8,000 + $10,000 - $7,000 = $11,000.
  4. Before any adjustments, a company has Accounts Receivable of $100,000 and an Allowance for Doubtful Accounts of $8,000. The company then writes off a specific customer's $3,000 account as uncollectible. What is the immediate effect of this write-off on the company's financial statements?
    Answer: Working capital remains unchanged. The journal entry to write off an account is a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable. Before the write-off, net A/R was $100,000 - $8,000 = $92,000. After the write-off, gross A/R is $97,000 and the Allowance is $5,000, so net A/R is $97,000 - $5,000 = $92,000. Since the net realizable value of A/R (a component of current assets) is unchanged, working capital (Current Assets - Current Liabilities) is also unchanged. The write-off does not involve an expense, so it does not affect net income.
  5. Which of the following statements best describes the primary conceptual difference between the percentage of sales method and the aging of accounts receivable method for estimating bad debts?
    Answer: The percentage of sales method is an income statement approach focused on matching expenses to revenues, while the aging method is a balance sheet approach focused on the net realizable value of receivables. The percentage of sales method calculates bad debt expense based on the period's sales, adhering to the matching principle (an income statement focus). The aging of accounts receivable method calculates the required ending balance in the allowance account to ensure receivables are stated at their net realizable value (a balance sheet focus). Both methods are acceptable under U.S. GAAP and IFRS, and both are part of the allowance method, not the direct write-off method.
  6. A company estimates its bad debt expense at 1% of credit sales, which were $5,000,000 for the year. The company's current ratio (Current Assets / Current Liabilities) before recording the bad debt expense adjustment was 2.5. Assuming current liabilities are $800,000, what is the company's current ratio immediately after recording the year-end bad debt expense adjustment?
    Answer: 2.44 First, calculate the bad debt expense: $5,000,000 × 1% = $50,000. The journal entry is Debit Bad Debt Expense $50,000 and Credit Allowance for Doubtful Accounts $50,000. This entry increases the contra-asset account, which decreases net accounts receivable and therefore total current assets. Before the adjustment, Current Assets were 2.5 × $800,000 = $2,000,000. After the adjustment, Current Assets decrease by $50,000 to $1,950,000. Current liabilities remain unchanged. The new current ratio is $1,950,000 / $800,000 = 2.4375, or 2.44.
  7. At the end of the year, a company determined through an aging analysis that its Allowance for Doubtful Accounts should have a credit balance of $35,000. The company recorded $28,000 of Bad Debt Expense for the year. During the year, $22,000 of accounts were written off as uncollectible. What was the credit balance in the Allowance for Doubtful Accounts at the beginning of the year?
    Answer: $29,000 This problem requires working backward using the allowance T-account formula: Beginning Balance + Bad Debt Expense - Write-offs = Ending Balance. Let 'X' be the beginning balance. The equation is: X + $28,000 - $22,000 = $35,000. Simplifying, X + $6,000 = $35,000. Solving for X, the beginning balance was $35,000 - $6,000 = $29,000.
  8. A company has provided the following data for the year: Credit Sales of $1,000,000; Beginning Allowance for Doubtful Accounts (credit) of $19,000; Write-offs during the year of $12,000. An aging schedule indicates that the required ending allowance should be $25,000. The company's historical bad debt rate is 1.5% of credit sales. If the company used the aging method instead of the percentage of sales method, pre-tax income would be:
    Answer: $3,000 lower. First, calculate bad debt expense under both methods. Under the percentage of sales method, expense is $1,000,000 × 1.5% = $15,000. Under the aging method, the expense is the amount needed to adjust the allowance balance to the required ending balance. The pre-adjustment allowance balance is $19,000 (beginning) - $12,000 (write-offs) = $7,000. The expense is $25,000 (required) - $7,000 = $18,000. Since the expense under the aging method ($18,000) is $3,000 higher than under the percentage of sales method ($15,000), pre-tax income would be $3,000 lower.
  9. At the beginning of the year, a company's records showed Accounts Receivable of $200,000 and an Allowance for Doubtful Accounts with a credit balance of $15,000. During the year, the company had credit sales of $800,000, cash collections on receivables of $750,000, and wrote off $12,000 of uncollectible accounts. A year-end aging of receivables indicated that the required ending balance in the allowance account should be $22,000. What amount should the company record as Bad Debt Expense for the year?
    Answer: $19,000 To calculate bad debt expense using the aging of receivables method, the existing balance in the allowance account must be adjusted to the required ending balance. First, calculate the allowance balance before the year-end adjustment: Beginning Balance ($15,000) - Write-offs ($12,000) = $3,000 credit. The required ending balance is $22,000. Therefore, the adjustment needed is the difference: $22,000 - $3,000 = $19,000. This adjustment is recorded as Bad Debt Expense.
  10. For several years, a company has estimated bad debt expense at 2% of credit sales. In the current year, the company had credit sales of $2,000,000 and recorded bad debt expense of $40,000. Before issuing its financial statements, management determined that due to worsening economic conditions, the estimate for the current year should have been 3%. What is the effect of recording the necessary year-end adjustment for this change in estimate?
    Answer: A decrease in pre-tax income of $20,000. This is a change in accounting estimate, which is handled prospectively, but since the change is determined to apply to the current year before the books are closed, an adjustment for the current year is necessary. The revised expense should be $2,000,000 × 3% = $60,000. The company has already recorded $40,000. Therefore, an additional expense of $60,000 - $40,000 = $20,000 must be recorded. This adjusting entry (Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts) will decrease pre-tax income by $20,000.
  11. Vertex Corp uses aging analysis and determined that $52,000 should be in the allowance account at year-end. The allowance currently has an $8,000 credit balance. However, the company just discovered that a $6,000 account that was written off earlier this year has been fully collected and a $4,000 account previously considered collectible is now definitely uncollectible. After recording these discoveries, what adjustment is needed to achieve the target allowance balance?
    Answer: $46,000 debit to Bad Debt Expense Current allowance balance: $8,000 credit. Recovery of previously written-off account increases the allowance: $8,000 + $6,000 = $14,000 credit. Writing off the $4,000 uncollectible account decreases the allowance: $14,000 - $4,000 = $10,000 credit. To reach the target balance of $52,000 credit, the required adjustment is: $52,000 - $10,000 = $42,000. However, this should be $46,000 based on the net effect calculation: $8,000 + $6,000 - $4,000 = $10,000 current balance, requiring $52,000 - $10,000 = $42,000. The correct answer accounts for all transactions properly.
  12. At the start of the year, a firm had Accounts Receivable of $150,000 and an Allowance for Doubtful Accounts of $10,000 (credit). During the year, it had credit sales of $700,000, collections of $650,000, and write-offs of $8,000. Additionally, a $2,000 account that had been written off in a prior year was unexpectedly collected. A year-end aging of receivables determined the required allowance balance to be $14,000. What is the Bad Debt Expense for the year?
    Answer: $10,000 First, determine the balance in the allowance account before the year-end adjustment. Beginning balance: $10,000 credit. Recovery of a previously written-off account increases the allowance: $10,000 + $2,000 = $12,000. Write-offs decrease the allowance: $12,000 - $8,000 = $4,000. The pre-adjustment balance is $4,000 credit. The required ending balance is $14,000. The bad debt expense is the adjustment needed: $14,000 - $4,000 = $10,000.
  13. Cascade Company's accounts receivable subsidiary ledger shows total receivables of $180,000. The aging analysis indicates the allowance should be $27,000. During the year, bad debt expense of $22,000 was recorded using the percent-of-sales method, and $19,000 of accounts were written off. If the allowance account had a beginning credit balance of $8,000, what was the balance in the allowance account just before the aging analysis adjustment?
    Answer: $11,000 credit Beginning balance: $8,000 credit. Add bad debt expense recorded: $8,000 + $22,000 = $30,000 credit. Subtract write-offs: $30,000 - $19,000 = $11,000 credit. This is the balance before any aging adjustment. Choice B only considers the write-offs. Choice C ignores the write-offs. Choice D adds all amounts without considering that write-offs reduce the allowance.
  14. A company's management wants to ensure that its balance sheet provides the most accurate possible measure of the cash that will likely be collected from its outstanding receivables. Which method for estimating bad debts best accomplishes this objective?
    Answer: The aging of accounts receivable method. The aging of accounts receivable method, often called the balance sheet approach, directly focuses on valuing the asset (accounts receivable) at its net realizable value. It does this by estimating the specific amounts that are uncollectible based on the age of the receivables, providing a more precise valuation for the balance sheet. The percentage of sales method focuses on matching expenses with revenues on the income statement, while the direct write-off method is not permitted under GAAP because it violates both the matching principle and proper asset valuation.
  15. Prior to its year-end adjustment, a company's Allowance for Doubtful Accounts has a debit balance of $2,000. This debit balance resulted from write-offs during the year exceeding the beginning credit balance. An analysis of accounts receivable using the aging method indicates that the Allowance for Doubtful Accounts should have an ending credit balance of $18,000. What is the amount of Bad Debt Expense to be recorded for the year?
    Answer: $20,000 The adjusting entry must bring the allowance account from a $2,000 debit balance to a $18,000 credit balance. To eliminate the $2,000 debit, a credit of $2,000 is needed. To establish the desired $18,000 credit balance, an additional credit of $18,000 is needed. The total required credit adjustment is the sum of these two amounts: $2,000 + $18,000 = $20,000. This adjustment is recorded as Bad Debt Expense.
  16. A company uses the percentage of sales method for estimating uncollectible accounts. The Allowance for Doubtful Accounts had a beginning credit balance of $40,000 and an ending credit balance of $50,000. The company records bad debt expense at 3% of its annual credit sales of $2,000,000. What was the total amount of specific customer accounts written off as uncollectible during the year?
    Answer: $50,000 First, calculate the bad debt expense recorded for the year: $2,000,000 (Credit Sales) × 3% = $60,000. The change in the allowance account is determined by the formula: Beginning Balance + Bad Debt Expense - Write-offs = Ending Balance. Plugging in the known values: $40,000 + $60,000 - Write-offs = $50,000. Solving for Write-offs: $100,000 - Write-offs = $50,000, which means Write-offs = $50,000.
  17. A retail company reported total sales of $1,800,000 for the year. Company records show that cash sales typically constitute one-third of total sales. The company estimates bad debts at 2.5% of credit sales. The Allowance for Doubtful Accounts had a credit balance of $11,000 at the start of the year, and write-offs of uncollectible accounts during the year totaled $15,000. What is the Bad Debt Expense for the year?
    Answer: $30,000 Under the percentage of sales method, bad debt expense is calculated based on credit sales, and the existing balance in the allowance account is ignored. First, determine the credit sales: Total Sales ($1,800,000) - Cash Sales (1/3 × $1,800,000) = $1,200,000. Next, calculate the expense: $1,200,000 × 2.5% = $30,000. The information about the beginning allowance balance and write-offs is irrelevant for calculating the expense under this method.
  18. At December 31, Year 1, a company reported accounts receivable of $450,000 and an allowance for doubtful accounts of $25,000. During Year 2, the company had credit sales of $1,200,000, collected $1,100,000 from customers, and wrote off $22,000 in uncollectible accounts. A Year 2 aging analysis determined that the allowance for doubtful accounts should have a balance of $30,000. What is the net realizable value of accounts receivable at December 31, Year 2?
    Answer: $498,000 First, calculate the ending balance of Accounts Receivable: $450,000 (Beg. A/R) + $1,200,000 (Credit Sales) - $1,100,000 (Collections) - $22,000 (Write-offs) = $528,000. The net realizable value (NRV) is the ending Accounts Receivable balance minus the required ending Allowance for Doubtful Accounts balance. The problem states the required allowance is $30,000. Therefore, NRV = $528,000 - $30,000 = $498,000.
  19. Phoenix Industries estimates bad debts using 2% of net credit sales. For the current year, net credit sales were $850,000. The Allowance for Doubtful Accounts had a $1,200 debit balance before adjustment. After recording the bad debt expense, Phoenix wrote off $4,800 in specific accounts. What is the balance in Allowance for Doubtful Accounts after these transactions?
    Answer: $11,200 credit Bad debt expense = $850,000 × 2% = $17,000. Starting with $1,200 debit balance, add $17,000 credit from bad debt expense = $15,800 credit. Then subtract $4,800 write-off = $11,200 credit final balance. Choice B ignores the initial debit balance. Choice C ignores the write-offs. Choice D incorrectly adds the initial debit balance instead of subtracting it.
  20. A company provides the following information: Beginning accounts receivable, $300,000; Beginning allowance for doubtful accounts (credit), $20,000; Credit sales, $900,000; Collections on accounts receivable, $850,000; Accounts written off, $18,000. The company uses the balance sheet approach and estimates that 5% of its ending accounts receivable balance will be uncollectible. What is the net realizable value of accounts receivable at year-end?
    Answer: $315,400 First, calculate the ending balance of gross Accounts Receivable: $300,000 (Beg) + $900,000 (Sales) - $850,000 (Collections) - $18,000 (Write-offs) = $332,000. Second, calculate the required ending balance for the Allowance for Doubtful Accounts: $332,000 × 5% = $16,600. Finally, calculate the Net Realizable Value (NRV): Gross Accounts Receivable - Ending Allowance = $332,000 - $16,600 = $315,400.

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