Problem 8-2B Estimating bad debt expense LO2, 3

CHECK FIGURES: 1b. Bad Debt Expense = $11,240 2. Accounts receivable (net) = $216,160

On December 31, 2020, Stilton Service Company's year-end, the unadjusted trial balance included the follow-ing items:

Account Debit credit Accounts receivable ..................... $239,000 Allowance for doubtful accounts .....................................$3100 Sales ($470,000 cash sales) ............................................1,128,000

 

Required 1. Prepare the adjusting entry on the books of Stilton Service Company to estimate bad debts under each of the following independent assumptions:

a. Bad debts are estimated to be 3% of credit sales.

b. An analysis suggests that 6% of outstanding accounts receivable on December 31, 2020, will become uncollectible.

2. Show how Accounts Receivable and the Allowance for Doubtful Accounts would appear on the December 31, 2020, balance sheet given the facts in requirement 1(a).

3. Show how Accounts Receivable and the Allowance for Doubtful Accounts would appear on the December 31, 2020, balance sheet given the facts in requirement 1(b).

Analysis Component: Would you recommend to Stilton that it use the income statement or the balance sheet approach to estimate uncollectible accounts receivable? Explain why, identifying advantages and dis-advantages for each approach

Answer:

1.(a) Debit bad debt expense by $19740 and credit allowance for bad debt by $19740

   (b)  Debit bad debt expense by $11240 and credit allowance for bad debt by $11240

2.  Taking the figures in question 1.(a) deduct an amount of $ 19740 from the account receivable balance of $239000 which would result in the balance of $219260 in account receivable Account

3. Taking the figures from question 1(b) deduct an amount of $14340 from the account receivable balance of $ 239000 which would result in the balance of $224660 in Account receivable balance

Stilton service company should prefer to use a Balance sheet method of calculating allowances as it is more precise compared to the income statement method.

Advantages of income statement approach:

• Simple method of estimating uncollectible debts

Disadvantages of income statement approach:

• Depend completely on credit sales
• Doesn't take into consideration the previous balances in allowance of bad debts when making present allowances.
• Not as precise as balance sheet method

Advantages of Balance sheet approach:

• More precise method of calculating allowance for bad debts
• Previous balance is considered while calculating allowances which eliminates the understatement of profits.
• Takes into account account receivable balance rather than total credit sales which gives the accurate results for allowances

Disadvantages:

• Complex calculations
• If any amount is taken wrong then there are chances of misstatement of accounts.

Stilton Service company should consider a balance sheet method for calculating allowances of bad debts as it is more precise and allowances can be calculated accurately.

References:

• https://opentextbc.ca/principlesofaccountingv1openstax/chapter/account-for-uncollectible-accounts-using-the-balance-sheet-and-income-statement-approaches/
• https://www.cliffsnotes.com/study-guides/accounting/accounting-principles-i/receivables/estimating-bad-debts-allowance-method#:~:text=If%20a%20company%20has%20%24500%2C000,for%20bad%20debts%20for%20%245%2C000.
• https://www.wikiaccounting.com/advantages-disadvantages-allowance-method/#:~:text=The%20allowance%20method%20lets%20us,or%20overstatement%20of%20profits%20arise.

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