Question

The December 31, 2019 statement of financial position of Howson Limited (Howson) showed Trade Accounts Receivable of $450,000 and a credit balance in Allowance for Doubtful Accounts of $45,000. During 2020, the following transactions occurred: Total service revenue of 2,000,000 was recognized of which 75% was billed on account; collections from customers totaled $1,300,000; accounts written off totaled $37,000; and previously written off accounts of $4,000 were collected.

Required

a) Journalize the 2020 transactions. (6 marks)

b) If the company uses the percentage of receivables basis to estimate bad debts expense and determines that uncollectible accounts are expected to be 5% of trade accounts receivable, prepare the adjusting entry at December 31, 2020?
   c) Management of Howson wants to show the highest possible net income for the year ended December 31, 2020. The president states, “one of my competitors told me that using % of credit sales method in determining our bad debt expense would increase the Company’s net income. Our industry average % of 2.4% is very reflective of our bad debt experience.”

    Required:

   

     The president of Howson has two questions she would like addressed.

1. First, would you recommend Howson adopt this method. (2 marks)

2. Secondly, regardless of your recommendation in (i), what amount would the net book value of the Accounts Receivable show on Howson’s Balance Sheet if the method were adopted?

Answer 1

a)

Account Titles	Debit	Credit
Cash	$          500,000
Accounts Receivable	$      1,500,000
Service Revenue		$       2,000,000
Cash	$      1,300,000
Accounts Receivable		$       1,300,000
Allowance for Doubtful Accounts	$            37,000
Accounts Receivable		$             37,000
Accounts Receivable	$              4,000
Allowance for Doubtful Accounts		$               4,000
Cash	$              4,000
Accounts Receivable		$               4,000

b)
Accounts Receivable Balance = $450000 + 1500000 - 1300000 - 37000 + 4000 - 4000 = $613000
Allowance for Doubtful Accounts Balance, Unadjusted = $45000-37000+4000 = $12000

Account Titles	Debit	Credit
Bad Debt Expense	$            18,650
Allowance for Doubtful Accounts		$             18,650

Bad Debt Expense = $613000*5%-12000

c)
i) I would not recommend using percent of sales method, since in this method, bad debt expense is recorded directly on the basis of credit sales assuming particular amount of credit sales would not be collected. The actual uncollectible amount could be recognized from analysis of accounts receivable which is not collected and assessing number of days it is due.

ii)
Bad Debt Expense = $1500000 x 2.4% = $36000
Allowance for Doubtful Debts Balance = $12000 + 36000 = $48000
Book Value of Accounts Receivable = $613000 - 48000 = $565000

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