Allowance Method of Accounting for Bad DebtsComparison of the Two Approaches Kandel Company had the following data available for 2017 (before making any adjustments): Accounts receivable, 12/31/17 $320,100 Allowance for doubtful accounts 2,600 Net credit sales, 2017 834,000 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 Operating Accounts Allowance for Doubtful Accounts Increase, Bad Debts Expense Increase Statement(s) Balance Sheet and Income Statement Feedback 1) Determine activity. 1a) Financing activities are transactions (other than payment of interest) involving borrowing from creditors or repaying creditors. This also includes transactions with the company's owners. Businesses borrow money or raise money from selling of their stock. 1b) Investing activities are obtaining money by building up operations or purchasing investment products such as stocks, bonds and annuities. 1c) Operating activities are the sale of products and/or services, and the costs incurred to operate a business. 2) Determine financial statement accounts affected, balance sheet or income statement. Determine accounts and amount of increases/decreases. 3) Balance Sheet accounts: Assets = Liabilities + Stockholders' Equity. (Equations must stay in balance) Income Statement accounts: Revenues Expenses = Net Income. 4) Allowance method estimates bad debts on the basis of either the net credit sales of the period or the accounts receivable at the end of the period. 5) Bad Debts Expense recognizes the cost associated with the reduction in asset value, Accounts Receivable. A contra-asset account is used to reduce the asset to its net realizable value. This is accomplished by creating an allowance account, Allowance for Doubtful Accounts. This is a contra account and causes total assets to decrease. 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 Allowance for Doubtful Accounts No Entry No Entry Bad Debts Expense 16,680 Feedback Partially correct (b) Kandel expects it will not be able to collect 6% of the balance in accounts receivable at year-end. Activity Operating Accounts Allowance for Doubtful Accounts Increase, Bad Debts Expense Increase Statement(s) Balance Sheet and Income Statement Feedback In applying the percentage of accounts receivable to estimate bad debts expense, the balance already in the allowance account is used and the focus is on the balance sheet. Multiply uncollectible percentage by the ending balance in accounts receivable. The amount determined uncollectible will be the new ending balance for the Allowance for Doubtful Accounts. The change in the Allowance account is the bad debt expense. 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 Allowance for Doubtful Accounts No Entry No Entry Bad Debts Expense 16,606 Feedback Partially correct 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 Operating Accounts Allowance for Doubtful Accounts Increase, Bad Debts Expense Increase Statement(s) Balance Sheet and Income Statement Feedback Under the percentage of credit sales approach the emphasis is on the bad debts expense and income statement. The balance in the allowance account before adjustment is ignored. 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 Allowance for Doubtful Accounts No Entry No Entry Bad Debts Expense 16,680 Feedback Partially correct (b) Kandel expects it will not be able to collect 6% of the balance in accounts receivable at year-end. Activity Operating Accounts Allowance for Doubtful Accounts Increase, Bad Debts Expense Increase Statement(s) Balance Sheet and Income Statement Feedback The amount determined uncollectible will be the new ending balance for the Allowance for Doubtful Accounts. The change in the Allowance account is the bad debt expense. 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 Allowance for Doubtful Accounts No Entry No Entry Bad Debts Expense 21,806 Feedback