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Chapter 7: Question: E7-10 (page 366)

(Bad-Debt Reporting) The chief accountant for Dickinson Corporation provides you with the following list of accounts receivable written off in the current year.

Date

Customer

Amount \(

March 31

E.L Masters Company

\)7,800

June 30

Stephen Crane Associates

6,700

September 30

Amy Lowell’s Dress Shop

7,000

December 31

R. Frost. Inc

9,830

Dickinson follows the policy of debiting Bad Debt Expense as accounts are written off. The chief accountant maintains that this procedure is appropriate for financial statement purposes because the Internal Revenue Service will not accept other methods for recognizing bad debts.

All of Dickinson’s sales are on a 30-day credit basis. Sales for the current year total \(2,200,000. The balance in Accounts Receivable at year-end is \)77,000 and an analysis of customer risk and charge-off experience indicates that 12% of receivables will be uncollectible (assume a zero balance in the allowance).

Instructions

(a) Do you agree or disagree with Dickinson’s policy concerning recognition of bad debt expense? Why or why not?

(b) By what amount would net income differ if bad debt expense was computed using the percentage-of-receivables approach?

Short Answer

Expert verified

Net income under the percentage method of calculating bad debt will be higher by$22,090.

Step by step solution

01

Definition of Direct Write Off Method

The method of reporting uncollectible amount under which a business entity directly debits bad debt expenses and credit accounts receivables is known as direct write-off method.

02

Justification of method used

Direct write-off method is not theoretically correct because it does not follow the matching principle of accounting. It does not report the accounts receivables in their net realizable value. Therefore, a business entity must not adopt direct write-off method.

03

Difference in net income when percentage method is used

Particular

Amount $

Direct write off method$7,800+$6,700+$7,000+$9,830

$31,330

Less: Percentage of receivables $77,000×12%

($9,240)

Difference in net income

$22,090

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Most popular questions from this chapter

Computing Bad Debts and Preparing Journal Entries) The trial balance before adjustment of Taylor Swift Inc. shows the following balances.

Debit

Credit

Accounts Receivable

\(90,000

Allowance for Doubtful Accounts

1,750

Sales revenue (all on credit)

\)680,000

Instructions

Give the entry for estimated bad debts assuming that the allowance is to provide for doubtful accounts on the basis of (a) 4% of gross accounts receivable and (b) 5% of gross accounts receivable and Allowance for Doubtful Accounts has a $1,700 credit balance.

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

How should Moresan account for the trade accounts receivable factored on November 1, 2017? Why?

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

(a) How should Moresan determine the interest revenue for 2017 on the:

(1) Interest-bearing note receivable? Why?

(2) Zero-interest-bearing note receivable? Why?

Finman Company designated Jill Holland as petty cash custodian and established a petty cash fund of \(200. The fund is reimbursed when the cash in the fund is at \)15, which it is. Petty cash receipts indicate funds were disbursed for office supplies \(94 and miscellaneous expense \)87. Prepare journal entries for the establishment of the fund and the reimbursement.

(Bad-Debt Reporting) Presented below is information related to the Accounts Receivable accounts of Gulistan Inc. during the current year 2017.

1. An aging schedule of the accounts receivable as of December 31, 2017, is as follows.

Age

Net Debit Balance

% to be applied after correction is made

Under 60-days

\(172,342

1%

60-90 days

136,490

3%

91-120 days

39,924

6%

Over 120 days

23,644

\)3,700 definitely uncollectible; estimated remainder uncollectible is 25%

\(372,400

*The \)3,240 write-off of receivables is related to the 91-to-120 day category.

2. The Accounts Receivable control account has a debit balance of \(372,400 on December 31, 2017.

3. Two entries were made in the Bad Debt Expense account during the year: (1) a debit on December 31 for the amount credited to Allowance for Doubtful Accounts, and (2) a credit for \)3,240 on November 3, 2017, and a debit to Allowance for Doubtful Accounts because of a bankruptcy.

4. Allowance for Doubtful Accounts is as follows for 2017.

Allowance for Doubtful Accounts

Nov 3

Uncollectible accounts written off

3,240

Jan 1

Beginning balance

8,750

Dec 31

5% of \(372,400

18,620

5. A credit balance exists in Accounts Receivable (60–90 days) of \)4,840, which represents an advance on a sales contract.

Instructions

Assuming that the books have not been closed for 2017, make the necessary correcting entries.
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