Financial Accounting: In an Economic Context

REVIEW PROBLEM

This section provides a review problem that covers the methods used to account for bad debts. The facts given are accounted for using the allowance method with a percentage-of-credit-sales estimate.

Assume that Credit Inc. began operations on January 1, 2011. The relevant transactions for 2011 and 2012 are summarized in the accounts receivable T-account provided in Figure 6-14. Sales on account during 2011 totaled $10,000, and cash receipts for those sales equaled $6,000. The accounts receivable balance at the end of 2011 was $4,000 ($10,000 — $6,000). Sales on account during 2012 totaled $12,000, and cash receipts during the same period, from sales made in both 2011 and 2012, were $11,000. On June 5, 2012, Credit Inc. received notice that a $500 account established in 2011 would not be collectible. This account was written off, and the December 31, 2012 balance in accounts receivable is $4,500 ($4,000 + $12,000 — $11,000 — $500). Assume that companies in Credit's industry typically experience bad debt losses of approximately 7 percent of credit sales.

The allowance method gives rise to end-of-period adjusting journal entries that decrease revenues in the appropriate period and reduce the value of accounts receivable on the balance sheet to net realizable value, the amount of cash expected to be collected from the receivables. The write-off entry on June 5, 2012, has virtually no effect on the financial statements of Credit Inc.

Note that the preadjustment balance ...