Bad Debt Expense Calculations, week 5 discussion help

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Just need a general response to the post below – doesn’t have to be extravagant but enough to let the the professor know this it’s understood.

Bad Debt Expense Calculations



Class,

  One of my classes a few
terms ago asked for an example or a bit better explanation regarding
calculating Bad Debt Expenses. The following is what I have come up
with.

  There are three basic methods for handling the calculation of Bad Debt Expense:

·  Direct Write Off
Method: Accounts Receivable are written off directly when it becomes
obvious that the account holder will not pay. (This is not an accrual
accounting method so there is no Allowance for Doubtful Accounts.)

·  Percent
of Net Sales Method: This is an accrual accounting method. The Bad Debt
Expense is calculated by multiplying the Net Sales (credit sales) by a
specific percentage. The results is the Bad
Debt Expense and is accrued directly into the Allowance for Doubtful
Accounts. NOTE: very important, there is no (that is NO) adjustment made
to the calculated Bad Debt Expense using this method. One more time,
biggest error students make is to try to alter the calculated Bad Debt
Expense by some balance that is left over from the prior accounting
period. Do not make that mistake.

Accounts
Receivable Method: (Also similar methods are called Percent of Accounts
Receivable Method or Ageing of Accounts Receivable): This is an accrual
accounting method. The amount of expected un-collectable accounts is
determined based on an analysis of the Accounts Receivable. (Ie.,
a percentage or an aging table of the year end balances in Accounts
Receivable.) NOTE: very important, we MUST take into consideration any
current balance left over from the prior accounting period in the
Allowance for Doubtful Accounts. The objective is to make an adjusting
entry to record the Bad Debt Expense that will result in the Allowance
for Doubtful Accounts becoming the exact amount that was calculated as
un-collectable.

Make sure that you read the question or exam problem carefully to determine exactly which method you are required to use.

  Now for some examples:

  Direct Write Off Method: Lloyd Products learned the Joe Smuck
has just skipped town and traveled to a country without an extradition
treaty with the US. Joe owes Lloyd $500. Prepare the appropriated
adjusting entry, Lloyd uses the Direct Write Off Method to account for
bad debts.

Bad Debt Expense

500

  Accounts Receivable, Joe Smuck

500

  Percent of Net Sales and Ageing of Accounts Receivable Methods:

  Case: Lloyd
Products is undecided about which base to use in estimating
un-collectible accounts. On December 31, 2005, the balance in Accounts
Receivable was $680,000 and net credit sales amounted to $3,900,000
during 2005.  An aging analysis of the accounts receivable
indicated that $38,000 in accounts are expected to be un-collectible.
Past experience has shown that about 1% of net credit sales eventually
are un-collectible. The Allowance for Doubtful Accounts has an
unadjusted debit balance on December 31, 2005 of $700.

  Percent of Net Sales Method: $3,900,000 * 1% = $39,000 bad debt expense.

Dec 31

Bad Debt Expense

39,000

  Allowance for Doubtful Accounts

39,000

  Note: I do not care
what the current balance is in the Allowance for Doubtful Accounts when
using the Percent of Net Sales Method. Make sure you remember this it is
critical.

  Accounts Receivable Method (Aging or Percent):
Now it is critical to remember that you were already told the desired
adjusted balance for the Allowance for Doubtful Accounts. The aging
analysis tells us the we current expect that $38,000 of our current Accounts Receivable to be un-collectable. Use a T-account to figure the needed adjusting entry.

 Allowance for Doubtful Accounts

 Un adj bal Dec 31  700

Adj entry  38,700 

Ending Balance  38,000 

Bad Debt Expense 

 Adj entry  38,700

  Note we are making
ending balance in the Allowance for Doubtful Accounts to be equal to the
amount of the expected (calculated) un-collectable accounts based on
some factor related to the Accounts Receivable.

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