Question

Brief Exercise 5-6 Record the adjusting for uncollectible accounts (LO5-5)

At the end of the year, Mercy Cosmetics’ balance of Allowance for Uncollectible Accounts is $400 (credit) before adjustment. The balance of Accounts Receivable is $15,000. The company estimates that 10% of accounts will not be collected over the next year.

What adjustment would Mercy Cosmetics record for Allowance for Uncollectible Accounts? (If no entry is required for a particular transaction/event, select "No Journal Entry Required" in the first account field.)

Answer 1

Facts of the question :

Allowance for uncollectible amounts is $ 400 (credit)

Balance of Accounts receivables is $ 15,000

Company estimates that 10 % of accounts will not be collected.

Concept :

Since the question is mentioning that 10% of accounts will not be collected, the allowance for uncollectible amounts is recognised in balance sheet approach . I.e., at the end of every year based on the previous year trends, the company estimates certain percentage of accounts will not be collected .

Thereby, allowance for uncollectible amounts at the year end should be equal to the said percentage derived by the company on the account receivables at the year end.

If there is any opening balance in allowance for uncollectible amounts, it should be adjusted whether to be reduced or increased so that the allowance for uncollectible amounts at the year end is equivalent to the percentage of uncollectible amounts of the account receivables.

The said increase or decrease shall be recorded as bad debts expense in the statement of profit or loss.

Application of concept:

In the given case 10% is estimated as uncollectible on $15,000 account receivables.

Thereby, allowance for uncollectible amounts at the year end should be 10% of $ 15,000 = $1,500.

However, there is a opening balance of 400 (credit) in allownace for uncollectible amounts . Thereby the difference between the 1500 and 400 i.e. $ 1,100 (1500-400) should be recognised as bad debts expense and should be credited to allowance for uncollectible amounts so that the year end allowance for uncollectible amounts will become $ 1,500 (400+1100).

Journal entry to record the same is as follows:

Bad debts Expense A/c Dr (Debit - Expense )

To Allowance for uncollectible amounts A/c (credit ),

Final answer :

Bad debts Expense A/c Dr $ 1,100

To Allowance for uncollectible amounts A/c (credit). $ 1,100.

Additional information ( For knowledge purpose):

1. In balance sheet net receivables ( Total account receivables less allowance for uncollectible amounts) will be disclosed as account receivables at the year end.

2. Under income statement approach allowance for uncollectible ammounts will be as a percentage of revenue based on the previous trends of the company and the same percentage of revenue i.e., estimation of uncollectible amounts will be recorded as bad debts expense.