Question

Michael’s Bookshelf specializes in used, rare, and out-of-print books. The store has a large base of repeat customers who purchase books on 30-day accounts. At 15 days overdue, each customer gets a phone call from Michael requesting payment. Michael has experienced a high success rate with this collection effort. Michael’s CPA is preparing year-end financial statements and has asked him for his estimate of uncollectible accounts. Michael has a balance of $65,000 in the Accounts Receivable account at the end of the year. He has analyzed his uncollectible accounts using an aging of the accounts receivable. He estimates that only 2.5 percent of his accounts receivable balance will not be collected. The Allowance for Doubtful Accounts has a credit balance of $210 in the trial balance.

1. Prepare the journal entry to record the bad debts expense at year end.(2.5 points)
2. Show the balance sheet presentation of the accounts receivable account. (2.5 points)
3. What is the amount of bad debts expense that appears on the income statement? How is this amount classified? (2.5 points)
4. What would be the justification, if any, for Michael to use the direct write-off method for accounting for uncollectible accounts? (2.5 points)

Answer 1

Based on the information available in the question, we can answer the various sub parts

Requirement A :-

Bad debts expense = $65,000 * 2.5% = $1,625

The Bad debt expense for the year = $1,625 - $210 credit balance of Allowance account = $1,415

The journal entry to record the bad debt expense would be:-

	Particulars	Amount	Amount
31st December	Bad Debts Expense A/c Dr. ($65,000 * 2.5%)	1,415
	To Allowance for Doubtful A/c		1,415
	(To record the Bad debt expense as on December 31

Requirement B :-

MARTIN COMMUNICATIONS INC.,
BALANCE SHEET
At March 31, 20X1
Assets		Liabilities
Current Assets		Accounts Payable	XXX
Accounts Receivable	65,000	Stockholders equity
Less:- Allowance for Uncollectible	(1,625)	Common stock	XXX
Accounts receivables, net	63,375	Retained earnings	XXX
Total Assets	63,375	Total liabilities and stockholders equity	-

Requirement C:-

The $1,415 expense for the current year is the total amount of Bad debt expense. This amount would be classified under the Selling & Operating expenses section of the income statement.

Requirement D:-

Per the observation of the question, we can understand that Michael estimates only 2.5% of his accounts receivable are part of the Bad Debts expense. If this amount is immaterials to the total sales made by Michael, he would be able to justify not recording the bad debts using the allowance method and rather using the Direct write off method.