1. Acceptable Methods: 1. Percent of Sales Approach 2. Accounts Receivable Approach 1 © 2013 McGraw-Hill Ryerson Limited. Estimating Bad Debts Expense LO 3

2. Also referred to as the Income Statement Approach. Based on idea that a percentage of a company’s credit sales are uncollectible. The primary focus is on matching bad debts expense with credit sales. 2 © 2013 McGraw-Hill Ryerson Limited. Percent of Sales Approach LO 3

3. Current Period Sales x Estimated Bad Debt % = Estimated Bad Debts Expense Percent of Sales Approach 3 © 2013 McGraw-Hill Ryerson Limited. Under this approach, bad debts expense is computed as follows: LO 3

4. Example: MusicLand has credit sales of $400,000 and estimates 0.6% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2,400 ($400,000 x.6%). The period end adjusting entry would be: Percent of Sales Approach 4 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense 2,400 Allowance for Doubtful Accounts 2,400 To record estimated bad debts LO 3

5. This method assumes that a percentage of Accounts Receivable is uncollectible. Using this method, we compute the estimate of the Allowance for Doubtful Accounts as: 5 © 2013 McGraw-Hill Ryerson Limited. Year-end Accounts Receivable x Est. Bad Debt % Percent of Accounts Receivable Approach LO 3

6. Percent of Accounts Receivable Approach 6 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense is computed as: Estimated adjusted balance in Allowance for Doubtful Accounts - Unadjusted year-end balance in Allowance for Doubtful Accounts = Estimated Bad Debts Expense The objective for the entry is to make the Allowance account balance equal to the portion of outstanding Accounts Receivable estimated to be uncollectible. LO 3

7. Assumes that the older the Account Receivable the more likely is will become uncollectible. Steps: 1. Group accounts based on how much time has passed since they were created. 2. Estimate rates of uncollectibility for each group. 3. Apply rate to each group to get the required balance for the Allowance account. 7 © 2013 McGraw-Hill Ryerson Limited. Aging of Accounts Receivable Approach LO 3

8. Example: At December 31, the receivables for DeCor were classified as follows: Aging of Accounts Receivable 8 © 2013 McGraw-Hill Ryerson Limited. LO 3

9. Using estimated bad debt percentages, DeCor would calculate the estimated uncollectible amount as follows: Aging of Accounts Receivable 9 © 2013 McGraw-Hill Ryerson Limited.    LO 3

10. Allowance for Doubtful Accounts Unadj. bal. 200 Adj. bal. 2,290 DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Aging of Accounts Receivable 10 © 2013 McGraw-Hill Ryerson Limited. LO 3

11. DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490. Aging of Accounts Receivable 11 © 2013 McGraw-Hill Ryerson Limited. Allowance for Doubtful Accounts Unadj. bal. 200 Adj. 2,490 Adj. bal. 2,290 LO 3

12. DeCor’s unadjusted balance in the allowance account is a debit of $200. The previous computation shows the desired balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490. Aging of Accounts Receivable 12 © 2013 McGraw-Hill Ryerson Limited. Bad Debts Expense 2,490 Allowance for Doubtful Accounts 2,490 To record estimated bad debts Allowance for Doubtful Accounts Unadj. bal. 200 2,490 Adj. bal. 2,290 LO 3

13. Sometimes used as an alternative to the Allowance method when uncollectible accounts are not material. The loss from an uncollectible account is recorded when it is determined to be uncollectible. This method does not satisfy the principles of prudence and matching. 13 © 2013 McGraw-Hill Ryerson Limited. Direct Write-off Method LO 3

14. Example: A specific customer’s account (Jack Kent) is considered uncollectible. The entry to record the write-off is: Bad Debts Expense 520 Accounts Receivable—Jack Kent 520 14 © 2013 McGraw-Hill Ryerson Limited. Writing Off a Bad Debt - Direct Write-off Method LO 3