Question

The allowance method will provide an estimate for bad debt expense, as well as estimate the balance for the allowance contra account to accounts receivable. How will the items affect the income and balance sheet? For example, how will changing the aging category data affect the accuracy and reliability of information reported? Will the balance sheet accounts be accurate if they are over/understated? How will the over/understatement of expenses, for example, affect the income statement?

Answer 1

Frame your answer from the following key points.

-An allowance for doubtful accounts, or bad debt reserve, is a contra asset account that decreases your accounts receivable.
- By creating an allowance for doubtful accounts entry, a company is estimating that some customers won’t pay you the money they owe.
- The allowance method usually refers to one of the two ways for reporting bad debts expense that results from a company selling goods or services on credit.
- Under the allowance method, a company records an adjusting entry at the end of each accounting period for the amount of the losses it anticipates as the result of extending credit to its customers.
- The entry will involve the operating expense account Bad Debts Expense and the contra-asset account Allowance for Doubtful Accounts.
- It will provide an estimate for bad debt expense and also estimate for the offset amount of accounts receivable.

How it will affect the income and balance sheet?

- The only impact that the allowance for doubtful accounts has on the income statement is the initial charge to bad debt expense when the allowance is initially funded. Any subsequent write-offs of accounts receivable against the allowance for doubtful accounts only impact the balance sheet.
- Bad debts will appear as an expense in the income statement at the end of the year.
- The allowance for doubtful accounts is a reduction of the total amount of accounts receivable appearing on a company's balance sheet, and is listed as a deduction immediately below the accounts receivable line item. Hence, the allowance for doubtful debts decreases the total value of current assets, as well as the total assets of the business.

- then Allowance For Doubtful Accounts shows less Closing Balance on Debit Side (Credit Balance) on its Ledger and hence as a result the amount of Contra Asset Account i.e., Allowance For Doubtful Accounts that is deducted from Closing Balance of Accounts Receivable on Balance Sheet will make its Net Relizable Value overstated. Also Net Income / Net Profit will also be overstated due to less recorded amount of Uncollectible Accounts Expense / Doubtful Debts on Income Statement. In order to Rectify this wrong reporting, the company need to add more value to the Allowance For Doubtful Accounts by credited it with the value required to add

If a the Allowance for Doubtful Accounts is Overstated, the allowance of Doubtful Accounts show more Closing Balance on Debit Side (Credit Balance) and as a result the Net Relizable value of Accounts Receivable understated. Also Net Income is understated due to more amount of Uncollectible Accounts Expense / Doubtful Debts is recorded on Income Statement. To Rectify this wrong reporting, the company need to deduct the excess amount from Allowance For Doubtful Accounts by debited it.