Question

When using the Allowance method to account for uncollectible accounts, between the income statement approach and the balance sheet approach, which is more accurate in your opinion? Fully support your answer with sound research.

Can the Allowance account be used to misinterpret a company's financial results? How so? Provide at least one example of how a company might accomplish this.

Suppose a company accepts a Note Receivable in lieu of an Accounts Receivable. How would the company record this transaction? Provide an example and related journal entry

Answer 1

1)a)Aging Method or Balance sheet approach

• This Method is very popular where company do mostly their business on credit.The accounts receivable are classified into different age groups or according to their collection period.the longer period the period an accounts receivable remains outstanding less are the chances of its collection.This method is typically known as aging of accounts receivable
• Under this method a percentage (based on past experience or historical data) of accounts receivable in each age group is considered uncollectible.the percentage differs for each age group.Each percentage is applied to individual amounts and then added up together to get to the total uncollectible amount at the end of the period

For Example:Company A has divided its accounts receivable in these age groups

	Total	Not yet due	1-30 days past due	31-60 days past due	61-90 dayspast due	over 90 days past due
Accounts Receivable	$50,000	$25,500	$14,500	$6,000	$1,500	$2,500

On the basis of past experience the company has determined the percentage of expected credit losses in each age group as follows:

• Not yet due: 1%
• 1 – 30 days past due: 3%
• 31 – 60 days past due: 15%
• 61 – 90 days past due: 25%
• Over 90 days past due: 60%

And company A has balance in allowance for doubtful accounts of $2,000 at beginning of period

Now we compute the amount of estimated uncollectibles:

	Total of age groups	Percentage considered uncollectible	Estimated uncollectible accounts
Not yet due	$25,500	1%	$255
1-30 days past due	$14,500	3%	$435
31-60 days past due	$6,000	15%	$900
61-90 days past due	$1,500	25%	$375
over 90 days past due	$2,500	60%	$1,500
Total	$50,000		$3,465

Journal Entry : The company would pass the following adjusting entry.Only The required amount of $1,465 will be passed through journal entry as you have already $2,000 in your allowance for doubtful accounts

No.	General Journal	Debit	Credit
	Uncollectible Accounts Expense	$1,465
	Allowance for doubtful debts		$1,465

b)The Sales Method or Income Statement Approach

Opposite to balance sheet approach no aging of debtors is done a percentage based on past experience is simply applied to credit sales and determined uncollectible.the adjusting entry is made with the full amount of estimated uncollectible i.e., without taking into account any existing balance in the allowance for doubtful accounts account.

This approach is very simple and straight forward and is usually used by small companies.

Taking the same example Company A has $50,000 credit sales and its management estimates 5% of total credit sales will be uncollectible & company A has balance in allowance for doubtful accounts of $2,000 at beginning of period

Allowance for doubtful accounts:$50,000*5%=$2,500

Adjusting Entry:

No.	Particulars	Debit	Credit
	Uncollectible accounts Expense	$2,500
	Allowance for doubtful debts		$2,500

Notice that the existing balance of $2,000 in the allowance for doubtful accounts account has been ignored while preparing above journal entry.

CONCLUSION:FROM ABOVE WE CAN SEE THAT-The sales method (or income statement approach) of estimating uncollectible accounts is simple and easy to employ but is less accurate and less reliable technique when compared with the aging method.

2)The allowance account could be used in the misinterpreting the bad debt estimates in the organization. An example of how the allowance account could be misinterpreted is through the booking of extreme unreasonable estimates of allowances in the financial statements. Such a situation would have a significant impact on the results of the financial statements. It is important that proper estimates of the allowances for doubtful debt should be done well.

3)Example:Company A sells Product A1 to B FOR $10,000 PAYMENT for which is due in 30 days.

So your Entry would be

Accounts Receivable........................................$10,000(Dr.)

Sales................................................................................$10,000(Cr.)

After 45 days of non payment you both agree that Company A will issue a notes receivable to B for $10,000 paid in two monthly installments with an interest of 5%

So your entry Will be to record notes receivable

Notes receivable..................................................$10,000(Dr.)

Account Receivable...........................................................$10,000(Cr.)

After 1 MONTH B pays $5,000 under terms of note as well as interest of $10000*5%*30/365=$41

Entry:

DATE	PARTICULARS	DEBIT	CREDIT
	CASH	$5,041
	NOTES RECEIVABLE		$5,000
	INTEREST INCOME		$41

at end of 2nd month B pays his last installment of $5,000 and interest of $5,000*5%*30/365=$21

entry:

DATE	PARTICULARS	DEBIT	CREDIT
	CASH	$5,021
	NOTES RECEIVABLE		$5,000
	INTEREST INCOME		$21