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 1⁄4% 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 Receivable Written Off as Uncollectible Year Sales Uncollectible 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 52,6005,100 12,500 $35,000
Instructions
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 1⁄4% of sales appear to be reasonably close to the actual experience with uncollectible accounts originating during the first two years? Explain.
Answer:
1.
Increase Balance of
Expense Expense (Decrease) Allowance
Actually Based on in Amount Account,
Reported Estimate of Expense End of Year
$18,000 $31,250 $13,250 $13,250
30,200 37,000 6,800 20,050
39,900 45,000 5,100 25,150
52,600 60,000 7,400 32,550
2. Yes. The actual write-offs of accounts originating in the first two years are
reasonably close to the expense that would have been charged to those years on
the basis of 1/4% of sales. The total write-off of receivables originating in the first
year amounted to $30,600 ($18,000 + $9,000 + $3,600), as compared to bad debt
expense, based on the percentage of sales of $31,250 ($12,500,000 × 0.0025). For the
second year, the comparable amounts were write-offs of $35,600 ($21,200 + $9,300 +
$5,100) and bad debt expense of $37,000 ($14,800,000 × 0.0025).