Question

Digital Depot Company, which operates a chain of 40 electronics supply stores, has just completed its fourth year of operations. The direct write-off method of recording bad debt expense has been used during the entire period. Because of substantial increases in sales volume and the amount of uncollectible accounts, the firm is considering changing to the allowance method. Information is requested as to the effect that an annual provision of ¼% of sales would have had on the amount of bad debt expense reported for each of the past four years. It is also considered desirable to know what the balance of Allowance for Doubtful Accounts would have been at the end of each year. The following data have been obtained from the accounts:

			Year of origin of accounts recievable written off as uncollectable
Year	Sales	Uncollectable accounts written off	1st	2nd	3rd	4th
1st	$12,500,000	$18,000	18,000
2nd	$14,800,000	30,200	9,000	$21,200
3rd	$18,000,000	39,900	3,600	9,300	27,000
4th	$ 24,000,000	52,600		5,100	12,500	$35,000

Now.

HINT for #1! The premise here is that the company has been using the direct write off method, and if the company had been using the allowance method (using % of sales), what the balance would have been to the allowance account. Under the direct write off method, you recognize bad debt expense only when you write off an account.  In year 1, they wrote off $18,000, so that is the bad debt expense as reported by the company (column 1).  Had they used the allowance method basing bad debt expense on 1/4 of 1% of sales, their bad debt expense would have been $31,250 (second column). The difference of the two would be the increase in bad debt expense (column 3), and this would also be the ending balance in the allowance account (increase of 31,250 credit minus the write off of 18,000 debit), which goes into column 4. You do the same for the subsequent years, where  the increase or decrease should be the difference between the first two columns while the last column should show the cumulative balance for the allowance account--beginning balance plus the bad debt expense estimated for the year minus the amount written off for the year.

1. Assemble the desired data, using the following column headings

Bad Debt Expense

Year Expense actually reported. Expense based on estimate Increase (decrease) in amount of expense Balance of allowance account, end of year

2. Experience during the first four years of operations indicated that the receivables either were collected within two years or had to be written off as uncollectible. Does the estimate of ¼% of sales appear to be reasonably close to the actual experience with uncollectible accounts originating during the first two years? Explain.

Answer 1

Schedule of Bad Debt Expense

Digital Depot Company
Schedule of Bad Debt Expense
Year	Expense Actually Reported (A)	Expense Based on Estimate (B)	Increase/(Decrease) in Amount of Expense [C= B-A]	Balance of Allowance Account, End of year
1	$18,000	$31,250	$13,250	$13,250
2	$30,200	$37,000	$6,800	$20,050
3	$39,900	$45,000	$5,100	$25,150
4	$52,600	$60,000	$7,400	$32,550

Working as follows:

Calculation of Expense Based on Estimate as follows:

Year 1	$12,500,000 × 0.25% = $31250
Year 2	$14,800,000 × 0.25% = $37,000
Year 3	$18,000,000 × 0.25% = $45,000
Year 4	$24,000,000 × 0.25% = $60,000

_______________________________________________________________________

2.

Compute Total Expense Under Direct write-off method as follows:

Year 1	$18,000 + $9,000 + $3600 = $30,600
Year 2	$21,200 + $9,300 + $5,100 = $35,600
Year 3	$27,000 + $12,500 = $39,500
Year 4	$35,000

The estimate of one-fourth sales is not appeared reasonably to close to the actual experience with uncollectible accounts.