Question

The adjusting entry used to record the estimated bad debts in the period credit sales occur decreases:

a. Both net income and net accounts receivable
b. Net income and increases liabilities
c. Assets and increases liabilities
d. Both selling expenses and net income

Answer 1

The adjusting entry for bad debts affects a business's accounting by debiting Bad Debts Expense and crediting Allowance for Doubtful Accounts, consequently decreasing both net income and selling expenses due to the recognition of bad debt expense.

Step-by-step explanation:

The adjusting entry for recording the estimated bad debts in the period when credit sales occur is an essential part of accrual accounting. This entry is intended to adhere to the matching principle, which states that expenses should be recognized in the same period as the revenues they help to generate. When a company makes a sale on credit, there is always a possibility that some amount may not be collected, becoming bad debts.

To account for this, businesses estimate bad debts and record them in the same period as the sales. This is done by debiting the Bad Debts Expense and crediting the Allowance for Doubtful Accounts. The Allowance for Doubtful Accounts is a contra-asset account that reduces the total Accounts Receivable on the balance sheet, while the Bad Debts Expense is recognized on the income statement. As a result, the net income is decreased because expenses are higher due to the recognition of the Bad Debts Expense. Moreover, it also increases the selling expenses on the income statement as bad debt expense is often categorized under selling or administrative expenses.