Question

Madison Corporation uses the allowance method to value its accounts receivable and is making the annual adjustments at fiscal year-end, November 30. The proportion of uncollectible accounts is estimated based on past experience, which indicates 1.5% of net credit sales will be uncollectible. Total sales for the year were $2,000,000, of which $200,000 were cash transactions. Madison has determined that the Norris Corporation accounts receivable balance of $10,000 is uncollectible and will write off this account before year-end adjustments are made. Listed below are Madison's account balances at November 30 prior to any adjustments and the $10,000 write-off.

Sales $2,000,000
Accounts receivable 750,000
Sales discounts 125,000
Allowance for doubtful accounts 16,500
Sales returns and allowances
175,000
Bad debt expense 0
As a result of the November 30 adjusting entry to provide for bad debts, the allowance for doubtful accounts will
a) Increase by $30,000.
b) Increase by $25,500.
c) Increase by $22,500.
d) Decrease by $22,500.

Answer 1

After subtracting the $10,000 write-off from the existing allowance account balance of $16,500 and calculating the needed $27,000 estimated uncollectible amount, Madison Corporation will need to increase its allowance for doubtful accounts by $20,500, as a result of the November 30 adjusting entry for bad debts.

Step-by-step explanation:

To answer the question regarding the adjustment to the allowance for doubtful accounts for Madison Corporation, we must first calculate the amount of the adjusting entry for bad debts. Madison Corporation uses 1.5% of net credit sales to estimate uncollectibles, so we must determine net credit sales which is total sales minus cash sales. In this case, total sales are $2,000,000 and cash sales are $200,000, which means net credit sales are $2,000,000 - $200,000 = $1,800,000. Applying the 1.5% rate to net credit sales, the estimated uncollectible amount is $1,800,000 × 0.015 = $27,000.

Prior to the adjustment, the Allowance for Doubtful Accounts has a balance of $16,500. Since Madison is writing off the Norris Corporation accounts receivable balance of $10,000, the allowance account will be reduced by that amount, leaving it at $6,500 ($16,500 - $10,000). After the adjustment, the allowance account should reflect the estimated uncollectible amount of $27,000. Therefore, the adjusting entry will be the difference between the current balance after write-off ($6,500) and the needed balance ($27,000), which is $27,000 - $6,500 = $20,500.

Thus, as a result of the November 30 adjusting entry to provide for bad debts, the allowance for doubtful accounts will increase by $20,500, not matching any of the provided options (a, b, c, or d).