Question

Metlock Company reports the following financial information before adjustments.

		Dr.			Cr.
Accounts Receivable		$140,500
Allowance for Doubtful Accounts					$3,730
Sales Revenue (all on credit)					816,400
Sales Returns and Allowances		53,360

Prepare the journal entry to record bad debt expense assuming Metlock Company estimates bad debts at (a) 4% of accounts receivable and (b) 4% of accounts receivable but Allowance for Doubtful Accounts had a $1,540 debit balance. (If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts. Credit account titles are automatically indented when the amount is entered. Do not indent manually.)

Answer 1

Part a.

In the current problem we can see that Metlock Company is having an Allowance for Doubtful Account balance of $3,730 and is estimating 4% of Accounts Receivable to be bad. Hence we need to reinstate the Allowance for Doubtful Accounts

i.e. Estimated Bad Debt = 140,500 * 4% = $5,620.

Balance as on Date in Allowance for Doubtful Account = $3,730.

Additional Provision needed = $5,620-$3,730 = $1,890.

Journal Entry

Profit and Loss Account - Debit - $1,890.

Allowance for Doubtful Accounts - Credit $1,890.

Now it is important to note that over here we are not touching the Accounts Receivable Account because what we have is an estimate of the Bad Debt which might happen. And in Balance Sheet we will show Accounts receivable less Allowance for Doubtful Accounts.

Part b

Now in part b we see that the estimation for Bad Debts is at 4% but the balance in Allowance for Accounts Receivable is Debit $1,540.

We need to keep Allowance for Doubtful Accounts at Credit $5,620 after all the adjustment i.e. 4% of Accounts Receivable.

Hence we need to provide = $5,620 (4% of Accounts Receivable) + 1540 (Debit Balance in Allowance)

Journal Entry

Profit and Loss Account - Debit - $ 7,160.

Allowance for Doubtful Accounts - Credit $7,160.

Hence net balance in Allowance for Accounts Receivable will = 7,160 - 1540 = 5,620 i.e. 4% of Accounts receivable.

It is important to understand that a Debit Balance in Allowance for Accounts Receivable indicates that the actual bad debts write off during the year has exceeded the allowance which was provided for at the last balance sheet date. Hence in order to re-instate the allowance for Accounts receivable at a balance sheet date we need to provide for gross value in Profit and Loss Account i.e. Balance needed + Debit Balance.

In case there was a credit balance like in part a then additional Allowance for Bad Debts which needs to provided in Profit and Loss account would have been = Balance Needed - Credit Balance.