[startupcfo]

Wren Company had the following account balances at December 31, Year 1:

Accounts receivable $ 900,000
Allowance for doubtful accounts before any provision for Year 1 doubtful accounts expense) 16,000
Credit sales for Year 1 1,750,000
Wren is considering the following method of estimating doubtful accounts expense for year 1:

• Based on credit sales at 2%
• Based on accounts receivable at 5%

What amount should Wren charge to doubtful accounts expense under each method?

5% of AR is 45K, so if we started off with 16K allowance, then we would boost the doubtful account expense by 29K. Makes perfect sense there.

2% of sales is $35,000. Since we’re already in for 16K, I would have boosted it by 19,000. However, the book is telling me to ignore the 16K doubtful allowance that is already there. That makes no sense to me. Why?

This answer is correct. When doubtful accounts expense is estimated based on sales, any balance in the allowance account is ignored when computing the expense. The formula to determine the expense is

(Net sales) × (Bad debt rate) = Expense
$1,750,00 × 2% = $35,000%
When doubtful accounts expense is estimated based on accounts receivable, the balance in the allowance account must be considered. This is correct because the formula is used to compute the desired ending balance in the allowance account, not the doubtful accounts expense.

(Accts. Receivable) × (Bad debt rate) = Allowance
$900,000 × 5% = $45,000
Since the allowance account already has a credit balance of $16,000, doubtful accounts expense of $29,000 must be recorded to bring the allowance up to $45,000 ($45,000 − $16,000 = $29,000).

AUD - 93
BEC - 87
FAR - 77
REG - 77

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Corporate finance leader

BEC - 87 | 02/28
REG - 70 | 06/10, REMATCH | 08/30
AUD - XX | 09/10
FAR - XX | 12/10

[Missy]

Because the assumption is the balance sitting in doubtful accounts relates to sales in a prior period when you're only using current period sales to accrue for bad debt. When you use a/r you're looking at all open receivables regardless of the period they happened.

Old timer,  A71'er since 2010.

Finance manager/HR manager

 

 

Licensed Massachusetts Non Reporting CPA since 2012
Finance/Admin/HR Manager

[Author]

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