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At December 31, 2016 , the Accounts Receivable balance of Solar Energy Manufacturing is $195,000. The Allowance for Bad
Debts account has a $17,125 debit balance. Solar Energy Manufacturing prepares the following aging schedule for its accounts
receivable:
1
(Click the icon to view the aging schedule.)
Requirements
1. Journalize the year-end adjusting entry for bad debts on the basis of the aging schedule. Show the T-account for the
Allowance for Bad Debts at December 31 , 2016.
2. Show how Solar Energy Manufacturing will report its net accounts receivable on its December 31 , 2016 , balance sheet.
Companies sell to their customers in cash or on account. Recall that sales "on account" are those where the customer promises
to pay the company at a later date. Sales on account create an accounts receivable asset for the company. Accounts
receivable, also called trade receivables, represent the right to receive cash in the future from customers for goods sold or for
services performed. Selling on account brings both a benefit and a cost. The benefit to a business is the potential increased
revenues and profits by making sales to a wider range of customers. The cost, however, is that some customers do not pay,
creating uncollectible receivables.
Customers' accounts receivables that are uncollectible must be written off or removed from the books because the company
does not expect to receive cash in the future. Instead, the company must record an expense associated with the cost of the
uncollectible account. This expense is called bad debts expense. There are two methods of accounting for uncollectible
receivables and recording
the related bad debts expense:
Direct write-off method2
Allowance method3
Requirement 1. Journalize the year-end adjusting entry for bad debts on the basis of the aging schedule. Show the T-account
for the Allowance for Bad Debts at December 31 , 2016.
Recall that the under the allowance method a business records a bad debts expense based on estimates. How do companies
determine the amount of bad debts expense when using the allowance method? Companies use their past experience as well
as considering the economy, the industry they operate in, and other variables. In short, they make an educated guess, called an
estimate. There are three basic ways to estimate uncollectibles:
Percent-of-sales4
Percent-of-receivables5
Aging-of-receivables6
Solar Energy Manufacturing estimates its bad debts using the aging of receivables. This method involves the following steps:
Step 1
Determine the target balance of Allowance for Bad Debts by using the age of each account.
Step 2
Determine the amount of bad debts expense by evaluating the allowance account.
Bad debts expense = Target balance - Unadjusted credit balance of Allowance for Bad Debts
OR
Bad debts expense = Target balance + Unadjusted debit balance of Allowance for Bad Debts
Begin by determining the target balance of Allowance for Bad Debts by using the age of each account.
Age of Accounts
1-30
Accounts Receivable
Days
$
31-60
55,000
Days
$
0.5 %
275
61-90
70,000
Days
$
4.0 %
$
2,800
Over 90
45,000
Days
$
9.0 %
$
4,050
Total
25,000
Balance
$ 195,000
45.0 %
$
11,250
$ 18,375
Remember that under the aging of receivables method, the adjustment to Bad Debt Expense is determined as the amount
necessary to achieve the target balance in the Allowance for Bad Debt account. In this case, the Allowance for Bad Debts
account has an unadjusted debit balance. Use the following table to determine the amount of bad debts expense. account.
Target Balance in
18,375
Bad Debt
Expense
+ $
17,125
35,500
Journalize the year-end adjusting entry for doubtful accounts on the basis of the aging schedule.
We will increase (credit) the Allowance for Bad Debt by the amount necessary to achieve the target balance ($35,500 ). The
offset to this entry is to increase (debit) the Bad Debt Expense. (Record debits first, then credits. Select the explanation on the
last line of the journal entry table.)
Date
Dec. 31
Debit
Credit
35,500
35,500
Show the T-account for the Allowance for Bad Debts at December 31 , 2016. The unadjusted balance has been entered into the
T-account. Post the adjusting entry and calculate the balance at December 31 , 2016.
Allowance for Bad Debts
Unadj.Bal.
17,125
35,500 Adj.
Requirement 2. Show how Solar Energy Manufacturing will report its net accounts receivable on its
December 31 , 2016 , balance sheet.
Accounts receivable is reported on the balance sheet at its net realizable value7 on the balance sheet. Subtracting the
allowance from accounts receivable yields the net amount the business expects to collect. This is the amount we want to show
on our financial statements. It would be misleading to show only the gross amount of accounts receivable when we know the
business will most likely not collect that entire amount.
Balance Sheet (Partial):
Current Assets:
Accounts Receivable
195,000
(18,375) $
176,625
1: Data Table
Age
of
Accounts
1-30 Days
Accounts Receivable
Estimated percent uncollectible
31-60 Days
55,000 $
0.5 %
70,000
4.0 %
45,000
9.0 %
25,000
45.0 %
Occasionally after a company writes off an account, the customer will decide to make payment. To account for this recovery,
the company must reverse the earlier write-off, and then will record the cash collection as follows:
DR. Accounts Receivable
DR. Cash
3: Allowance method
The allowance method is based on the matching principle; thus, the key concept is to record bad debts expense in the same
period as the sales revenue. The offset to the expense is a contra asset account called Allowance for Bad Debts. The
allowance account reduces the asset Accounts Receivable. The business does not wait to see which customers will not pay.
Instead, it records a bad debts expense based on estimates developed from past experience and uses the Allowance for Bad
Debts to hold the pool of "unknown" uncollectible accounts.
When using the allowance method, companies still write off accounts receivables that are uncollectible. However, instead of
recording a debit to Bad Debts Expense (as done when using the direct write-off method), the company will record a debit to
Allowance for Bad Debts. Bad Debts Expense is not debited when a company writes off an account receivable when using the
allowance method because the company has already recorded the Bad Debt Expense as an adjusting entry. The entry to write
off an account under the allowance method has no effect on net income at the time of entry.
DR. Allowance for Bad Debts
Customers will occasionally make payment on receivables that have already been written off. A business will need to reverse
the write-off to the Allowance for Bad Debts account and then record the receipt of cash. In reversing the write-off, the
business is re-establishing the receivable account and reversing the write-off from the Allowance for Bad Debts account.
DR. Accounts Receivable
DR. Cash
4: Denition
The percent-of-sales method computes bad debts expense as a percentage of net credit sales. (Some companies will use all
sales not just credit sales.) This method is also called the income-statement approach because it focuses on the amount of
expense that is reported on the income statement.
5: Denition
The percent-of-receivables method is based on the balance of accounts receivable. This approach is also called the
balance-sheet approach because it focus on Accounts Receivable (a balance sheet account) and determine a target
allowance balance based on a percentage of the receivable balance. In the percent-of-receivables method, the business
determines a percentage of uncollectible accounts based on past experience. This method is different than the
percent-of-sales method because it multiplies the percentage by the ending unadjusted balance in the Accounts Receivable
account instead of by net credit sales.
6: Denition
The aging-of-receivables method is similar to the percentage-of-receivables method. This approach is also called a
balance-sheet approach because it focus on Accounts Receivable (a balance sheet account). However, in the aging method,
businesses group individual accounts according to how long the receivable has been outstanding. Then they apply a different
percentage uncollectible on each aging category.
7: Denition
Net realizable value is the net value the company expects to collect from its accounts receivables. Net realizable value is
calculated as follows:
Net Realizable Value = Accounts Receivable Allowance for Bad Debts
YOU ANSWERED:
Age
of
Accounts
1-30
Days
Accounts Receivable
Target Balance in
18,375
Date
Dec. 31
55,000
Days
61-90
nothing
Over 90
Days
$ 45,000
Total
25,000
9.0 %
Balance
nothing
45.0 %
nothing
nothing
nothing
Bad Debt
Expense
nothing
+ $
17,125
Accounts
and
Explanation
Debit
nothing
nothing
Days
4.0 %
nothing
$ 70,000
0.5 %
31-60
nothing
Credit
nothing
nothing
nothing
nothing
Allowance
for
Bad
Debts
Unadj.Bal.
17,125
nothing nothing
nothing
nothing
nothing nothing
nothing
nothing
nothing nothing
Balance
Sheet
(Partial):
Current Assets:
Accounts Receivable
nothing
nothing
nothing