Problem Solving Survival Guide to accompany Financial Accounting, 8th Edition

SOLUTION TO EXERCISE 8-1

1. When using the allowance method of accounting for bad debts, there are two methods available for determining the amount of the adjusting entry to record bad debt expense and to adjust the allowance account. They are:
   1. The percentage-of-sales basis: This method focuses on estimating bad debt expense. The average percentage relationship between actual bad debt losses and net credit sales (or total credit sales) of the period is used to determine the amount of expense for the period. That is, this method focuses on the matching of current bad debt expense with revenues of the current period and thus emphasizes the income statement. The amount of bad debt expense is simply calculated and recorded; a byproduct of this approach is the increase in the allowance account.

      TIP: The allowance method calls for the recognition of bad debt expense in the same period as the revenues that were recognized when the receivables originated rather than waiting to recognize expense until the period the receivables are deemed to definitely be uncollectible. This exercise is looking at two different approaches (methods) of applying this method.

   2. The percentage-of-receivables basis: This method focuses on estimating the cash (net) realizable value of the current receivables and thus emphasizes the balance sheet. It only incidentally measures bad debt expense; the expense reported may not be the best figure to match with the amount of credit sales of the current period. If this ...