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Activation Exercise 9-1: Allowance Method Terms and Definitions Revenues are increases in owner's equity that a business generates by selling goods or providing services. When a business agrees to accept payment in the future for goods and services provided today, the claim against the customer is called an account receivable and is recorded as an asset on the balance sheet. Feedback Check My Work When a business invoices a customer on account, it opens up the possibility that the customer may not ever pay in the future. Understanding the Business Transaction when credit is granted. At the No matter how careful a company is in granting credit, some customers will not pay their accounts. That is, some accounts receivable will become uncollectible. The specific accounts receivable that will become uncollectible are unknown end of the accounting period, the company must estimate the total amount of accounts receivable that will become uncollectible. Feedback Check My Work A business estimates the amount of its accounts receivable it will not collect and discloses this on the balance sheet. Recording in the Accounting System The operating expense used to record uncollectible accounts receivable is called bad debt expense The allowance method estimates the uncollectible accounts receivable at the end of the period, and records Bad Debt Expense as an adjusting entry at the end of the accounting period . On the date the bad debt expense is recorded, the company does not know which customer accounts will be uncollectible. Therefore, the specific customer accounts cannot be decreased. The estimate of uncollectible accounts is recorded as a credit - to Allowance for Doubtful Accounts. Teddy Company began operations on January 1, 20X1. The company has an accounts receivable balance of $412,700 at the end of its accounting period on December 31, 20X1. This balance includes some past due accounts. Based on industry averages, Teddy estimates that $22,890 of the December 31 accounts receivable will become uncollectible. At this time, Teddy Company does not know which customer accounts will become uncollectible. Feedback Check My Work Under the allowance method, the Bad Debt Expense account is used to record the amount of accounts receivable a business expects to have to write off in the upcoming year. The adjusting entry that Teddy Company should record for bad debt expense on December 31, 20x1 is: 12/31/X1 Bad Debt Expense 15,640 Allowance for Doubtful Accounts 15,640 X Feedback Check My Work Under the allowance method, the adjusting entry to record bad debt expense is estimated at the end of the period. It will yield an adjusted balance for the Allowance for Doubtful Accounts equal to the estimated amount. the balance in Accounts Receivable. This amount is called the On the income statement, the Bad Debt Expense will be matched against revenues net realizable value and represents the amount that the company expects V. On the balance sheet, the Allowance for Doubtful Accounts will be subtracted from to collect on its accounts receivable. Teddy Company's Accounts Receivable and Allowance for Doubtful Accounts on December 31, 20x1, before adjusting entries, are shown below. Update these T-accounts for the adjusting entry for Bad Debt Expense, showing the balance in Teddy Company's Accounts Receivable and Allowance for Doubtful Accounts after adjusting entries have been made. Accounts Receivable 12/31/X1 $412,700 12/31/X1 Allowance for Doubtful Accounts $0 1/1/X1 adjusting entry 12/31/X1 Determine the amount of Bad Debt Expense that Teddy Company should report in its 20X1 income statement and the net realizable value of Teddy Company's Accounts Receivable after the adjusting entry is made on December 31, 20X1. Income Statement: Bad Debt Expense Balance Sheet: ini 0 Accounts Receivable, Dec. 31, 20X1 Less: Allowance for Doubtful Accounts Net Realizable Value of Accounts Receivable, Dec. 31, 20x1 and crediting At a(n) unknown point in the future, specific customer accounts will be determined to be uncollectible. At that point in time, the specific account receivable is written off by debiting Allowance for Doubtful Accounts Accounts Receivable - specific customer Feedback Check My Work Accounts Receivable is an asset account; Allowance for Doubtful Accounts is a contra asset account that indicates the estimated amount of the accounts receivable that is uncollectiable. On January 12, 20x2, J. Thorleif's account balance of $6,380 with Teddy Company is determined to be uncollectible. Provide the journal entry to write-off J. Thorleif's account receivable on January 12, 20X2: 1/12/X2 Allowance for Doubtful Accounts Accounts Receivable - J. Thorleif Feedback Check My Work The write off of all or part of a customer's account reduces the balance in both Accounts Receivable and Allowance for Doubtful Accounts. Teddy Company's Accounts Receivable and Allowance for Doubtful Accounts on December 31, 20x1, after adjusting and closing entries, are shown below. Update these T-accounts for the write-off of the ). Thorleif account receivable, showing the balance in Teddy Company's Accounts Receivable and Allowance for Doubtful Accounts immediately following the write-off. Accounts Receivable 12/31/X1 1/12/X2 1/12/X2 Allowance for Doubtful Accounts 12/31/X1 1/12/X2 1/12/X2 Feedback Check My Work Under the allowance method, when a customer's account is identified as uncollectible, it is written off against the contra asset allowance account that was previously established based on estimates. This requires the company to remove the specific accounts receivable and an equal amount from the allowance account. Financial Statement Impact Dacher Company began operations on January 1, 20X1. On December 31, 20x1, the company has an accounts receivable balance of $260,000. Click here to use the sliders provided for the estimate of Bad Debt Expense on December 31, 20X1 and the write-off of Accounts Receivable on January 26, 20x2 to answer the following questions. 1. Answer parts a., b., C., and d. assuming the company estimates Bad Debt Expense of $15,000 on December 31, 20x1 based on industry averages. a. How much Bad Debt Expense will Dacher Company report on its 20X1 income statement? $ 8,960 x b. What will be the net realizable value of Dacher Company's Accounts Receivable on December 31, 20X1? $ C. As Dacher Company's estimate of Bad Debt Expense increases, the balance in the Allowance for Doubtful Accounts will increase . d. As Dacher Company's estimate of Bad Debt Expense increases, the net realizable value of Dacher Company's Accounts Receivable will decrease 2. Answer parts a., b., C., and d. presuming the company estimated bad debt of $15,000 and then writes off $2,500 of Accounts Receivable on January 26, 20x2. a. What will be the balance in the Allowance for Doubtful Accounts on January 31, 20x2 following the write-off of Accounts Receivable? $ b. What will be the net realizable value of Dacher's Accounts Receivable on January 31, 20x2 following the write-off of Accounts Receivable? $ c. As the amount of Accounts Receivable that Dacher Company writes off increases, the balance in the Allowance for Doubtful Accounts will decrease . d. As the amount of Accounts Receivable that Dacher Company writes off increases, the net realizable value of Dacher Company's Accounts Receivable will remain the same Feedback Check My Work Use the sliders to change the estimate of the dollar amount of bad debt expense (for question #1, and the dollar amount of Accounts Receivable written off (question #2). The Bad Debt Expense estimate selected in question 1 will affect the end-of-period adjusting entry. The Accounts Receivable write-off in question 2 will impact the balances in both Accounts Receivable and the Allowance for Doubtful Accounts. Feedback Check My Work Partially correct