Question

Sawyer, Inc. consistently estimated its bad debt expense at 1 percent of credit sales. In 2017, however, Sawyer determines that it must revise upward the estimate of bad debts for the current year’s credit sales to 2%, or double the prior years’ percentage. Sawyer uses the revised estimate of 2% and calculates bad debt expense of $500,000. How is the change in the estimated bad debt expense reported in Sawyer’s 2017 financial statements?

A) $500,000 of expense reported as a change in accounting principle and accounted for under the retrospective approach.
B) $500,000 of expense in the income statement and $500,000 as a contra asset in the balance sheet.
C) $500,000 of expense in the income statement as an ordinary item, $500,000 of expense reported as an adjustment to the beginning balance of retained earnings (net of tax).
D) $500,000 of expense and $500,000 as an unusual loss in the income statement.

Answer 1

The change in estimated bad debt expense should be reported prospectively in the income statement and as a contra asset in the balance sheet. The correct reporting for Sawyer, Inc.'s revised bad debt expense of $500,000 is as a $500,000 expense on the income statement and a $500,000 increase in the allowance for doubtful accounts on the balance sheet.

Step-by-step explanation:

The change in estimated bad debt expense for Sawyer, Inc. would be reported in its 2017 financial statements as a change in accounting estimate. When a company revises its estimation technique or its estimation rate of bad debts, it is not treated as a change in accounting principle. Instead, the change is accounted for prospectively. The appropriate way to report the increase to a 2% bad debt expense rate, resulting in a $500,000 expense, is to include this expense in the income statement for the period in which the change occurs. Accordingly, the correct answer is:

B) $500,000 of expense in the income statement and $500,000 as a contra asset in the balance sheet.

The bad debt expense would be reported on the income statement affecting the net income for the year and the allowance for doubtful accounts (contra asset) would be reported on the balance sheet, reducing the accounts receivable balance.

Answer 2

The answer is B

Step-by-step explanation:

The detailed accounting entry will be:

Dr Bad Debt Expenses $500,000

Cr Provision for account receivable $500,000

( to record estimation of bad debt over credit sales)

From the detailed entry, the Dr side will go into Income Statement as a type of expense and the Cr side will go into Balance Sheet as contra asset.

Answer A is not right because the re-estimation of bad-debt percentage is not a change in accounting principle

Answer C is not right because the re-estimation of bad-debt percentage in this case does not require adjustment in the beginning balance of retained earning

Answer D is not right because it is not complete ( it does not mention the increase in the contra asset account Provision for account receivable) and it duplicate the record of bad debt expenses ( it has been recorded as expense and unusual loss at the same time).