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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

Use the information presented in BE7-12 for Arness Woodcrafters but assume that the recourse liability has a fair value of \(4,000, instead of \)8,000. Prepare the journal entry and discuss the effects of this change in the value of the recourse liability on Arness’s financial statements.

Jim Carrie Company shows a balance of \(181,140 in the Accounts Receivable account on December 31, 2017. The balance consists of the following.

Installment accounts due in 2018

\)23,000

Installment accounts due after 2018

34,000

Overpayment to vendors

2,640

Due from regular customers, of which $40,000 represents account pledge as security for a bank loan

79,000

Advances to employees

1,500

Advance to the subsidiary company (due in 2018)

81,000

Instructions

Illustrate how the information above should be shown on the balance sheet of Jim Carrie Company on December 31, 2017.

Clark Pierce conducts a wholesale merchandising business that sells approximately 5,000 items per month with a total monthly average sales value of $250,000. Its annual bad debt rate has been approximately 1½% of sales. In recent discussions with his bookkeeper, Mr. Pierce has become confused by all the alternatives apparently available in handling the Allowance for Doubtful Accounts balance. The following information has been presented to Pierce.

1. An allowance can be set up (a) on the basis of a percentage of receivables or (b) on the basis of a valuation of all past due or otherwise questionable accounts receivable. Those considered uncollectible can be charged to such allowance at the close of the accounting period, or specific items can be charged off directly against (1) Gross Sales or to (2) Bad Debt Expense in the year in which they are determined to be uncollectible.

2. Collection agency and legal fees, and so on, incurred in connection with the attempted recovery of bad debts can be charged to (a) Bad Debt Expense, (b) Allowance for Doubtful Accounts, (c) Legal Expense, or (d) Administrative Expense.

3. Debts previously written off in whole or in part but currently recovered can be credited to (a) Other Revenue, (b) Bad Debt Expense, or (c) Allowance for Doubtful Accounts.

Instructions

Which of the foregoing methods would you recommend to Mr. Pierce in regard to (1) allowances and charge-offs, (2) collection expenses, and (3) recoveries? State briefly and clearly the reasons supporting your recommendations.

(Expected Cash Flows) On January 1, 2017, Botosan Company issued a \(1,200,000, 5-year, zero-interest bearing note to National Organization Bank. The note was issued to yield 8% annual interest. Unfortunately, during 2018 Botosan fell into financial trouble due to increased competition. After reviewing all available evidence on December 31, 2018, National Organization Bank decided that the loan was impaired. Botosan will probably pay back only \)800,000 of the principal at maturity.

Instructions

(a) Prepare journal entries for both Botosan Company and National Organization Bank to record the issuance of the note on January 1, 2017. (Round to the nearest $10.)

(b) Assuming that both Botosan Company and National Organization Bank use the effective-interest method to amortize the discount, prepare the amortization schedule for the note.

(c) Under what circumstances can National Organization Bank consider Botosan’s note to be impaired?

(d) Compute the loss National Organization Bank will suffer from Botosan’s financial distress on December 31, 2018. What journal entries should be made to record this loss?

What is “imputed interest”? In what situations is it necessary to impute an interest rate for notes receivable? What are the considerations in imputing an appropriate interest rate?
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