Question

Effect of recognizing uncollectible accounts on the financial statements: percent of receivables allowance method LO 7-2 [The following information applies to the questions displayed below.]

Leach Incorporated experienced the following events for the first two years of its operations.
Year 1:
1. Issued $28,000 of common stock for cash.
2. Provided $97,800 of services on account.
3. Provided $54,000 of services and received cash.
4. Collected $87,000 cash from accounts receivable.
5. Paid $56,000 of salaries expense for the year.
6. Adjusted the accounting records to reflect uncollectible accounts expense for the year. Leach estimates that 5 percent of the ending accounts receivable balance will be uncollectible.
7. Closed the revenue account. 8. Closed the expense accounts.
Year 2:
1. Wrote off an uncollectible account for $1,550.
2. Provided $106,000 of services on account.
3. Provided $50,000 of services and collected cash.
4. Collected $99,000 cash from accounts receivable.
5. Paid $83,000 of salaries expense for the year.
6. Adjusted the accounts to reflect uncollectible accounts expense for the year. Leach estimates that 5 percent of the ending accounts receivable balance will be uncollectible.
7. Closed the revenue account. 8. Closed the expense accounts.

Answer 1

Recognizing uncollectible accounts using the percent of receivables allowance method affects the balance sheet by reducing accounts receivable and impacts the income statement by increasing bad debt expense. This practice results in a more accurate representation of a company's financial health.

Step-by-step explanation:

The recognition of uncollectible accounts on financial statements is an essential aspect of accounting, particularly when using the percent of receivables allowance method. When a company like Leach Incorporated predicts that a percentage of its accounts receivable will not be collected, it must adjust its financial records accordingly. The estimation involves creating an allowance for doubtful accounts, which is a contra-asset account that reduces the total accounts receivable balance on the balance sheet to reflect expected defaults. This anticipation is recorded as bad debt expense in the income statement, further affecting net income. When actual write-offs occur, like Leach's $1,550 uncollectible account in Year 2, there's no impact on net income as the expense has already been recognized—it merely reduces both the allowance for doubtful accounts and the accounts receivable by the write-off amount.

For Leach Incorporated, the effect of this on the balance sheet is a more accurate representation of the cash flow the company can expect to receive. On the income statement, recognizing the expense for uncollectible accounts ensures that revenues are not overstated and expenses are recognized in the period in which the related revenue is earned, adhering to the matching principle of accounting.