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Chapter 7: 1CA (page 376)

Simms Company has significant amounts of trade accounts receivable. Simms uses the allowance method to estimate bad debts instead of the direct write-off method. During the year, some specific accounts were written off as uncollectible, and some that were previously written off as uncollectible were collected.

Instructions

(a) What are the deficiencies of the direct write-off method?

(b) Briefly describe the allowance method to estimate bad debts and the theoretical justification for its use?

(c) How should Simms account for the collection of the specific accounts previously written off as uncollectible?

Short Answer

Expert verified
  1. Matching principle of accounting is not followed under the direct write-off method.
  2. Net realizable value of accounts receivable is calculated under the allowance method.
  3. One entry for the re-statement of accounts receivables and one entry for cash collection.

Step by step solution

01

Definition of Net Realizable Value

The value representing the amount of money that can be generated through the sale of the current asset is known as net realizable value.

02

Deficiencies of direct-write off method

Under the direct write-off method, the accounts receivables are not reported on their net realizable value. It also does not write off bad debts in the same period of revenue generation and therefore does not comply with the matching principle.

03

Justification of allowance method

The allowance method is theoretically justified because it reports the accounts receivables on their net realizable value. Under the allowance method, the bad debts are estimated as a percentage of the balance of accounts receivables.

04

Reporting recovery of bad debts

Two journal entries will be made:

Date

Accounts and Explanation

Debit $

Credit $

1

Accounts receivables

xxx

Allowance for doubtful accounts

xxx

2

Cash

xxx

Accounts receivables

xxx

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Most popular questions from this chapter

What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?

What is the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts?

What are two methods of recording accounts receivable transactions when a cash discount situation is involved? Which is more theoretically correct? Which is used in practice more of the time? Why?

Wood Incorporated factored $150,000 of accounts receivable with Engram Factors Inc. on a without-recourse basis. Engram assesses a 2% finance charge of the amount of accounts receivable and retains an amount equal to 6% of accounts receivable for possible adjustments. Prepare the journal entry for Wood Incorporated and Engram Factors to record the factoring of the accounts receivable to Engram.

On July 1, 2017, Moresan Company sold special-order merchandise on credit and received in return an interest-bearing note receivable from the customer. Moresan will receive interest at the prevailing rate for a note of this type. Both the principal and interest are due in one lump sum on June 30, 2018.

On September 1, 2017, Moresan sold special-order merchandise on credit and received in return a zero-interest-bearing note receivable from the customer. The prevailing rate of interest for a note of this type is determinable. The note receivable is due in one lump sum on August 31, 2019.

Moresan also has significant amounts of trade accounts receivable as a result of credit sales to its customers. On October 1, 2017, some trade accounts receivable were assigned to Indigo Finance Company on a non-notification (Moresan handles collections) basis for an advance of 75% of their amount at an interest charge of 8% on the balance outstanding.

On November 1, 2017, other trade accounts receivable were sold without recourse. The factor withheld 5% of the trade accounts receivable factored as protection against sales returns and allowances and charged a finance charge of 3%.

Instructions

(b) How should Moresan report the interest-bearing note receivable and the zero-interest-bearing note receivable on its balance sheet at December 31, 2017?

See all solutions

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