Question

Effect of doubtful accounts on net income

During its first year of operations, Mack's Plumbing Supply Co. had sales of $320,000, wrote off $5,000 of accounts as uncollectible using the direct write-off method, and reported net income of $35,200.
Assume that during the second year of operations Mack's Plumbing Supply Co. had sales of $384,000, wrote off $6,000 of accounts as uncollectible using the direct write-off method, and reported net income of $38,400.
a. Determine what net income would have been in the second year if the allowance method (using 1% of sales) had been used in both the first and second years. ___$
b. Determine what the balance of the allowance for doubtful accounts would have been at the end of the second year if the allowance method had been used in both the first and second years. If required, use the minus sign to indicate a "debit" balance. ___$

Answer 1

If the allowance method had been used, the net income in the second year would be $35,600 and the balance of allowance for doubtful accounts at the end of the second year would be $7,040.

Step-by-step explanation:

If the allowance method had been used in both the first and second years, the effect on net income in the second year would depend on the balance of the allowance for doubtful accounts at the end of the first year. Since the allowance is based on 1% of sales, the allowance for doubtful accounts at the end of the first year would be $3,200 (1% of $320,000). In the second year, $6,000 of accounts were written off, so the net income would be reduced by $6,000. However, since the balance of the allowance for doubtful accounts at the end of the first year was only $3,200, an additional $2,800 ($6,000 - $3,200) would need to be deducted from net income, resulting in a net income of $35,600 in the second year.

The balance of the allowance for doubtful accounts at the end of the second year would be the starting balance of $3,200 plus the new provision for doubtful accounts, which is 1% of the sales in the second year. The provision for doubtful accounts in the second year would be $3,840 (1% of $384,000). So the balance of the allowance for doubtful accounts at the end of the second year would be $7,040 ($3,200 + $3,840).