Question

Apply the allowance method: Mouse Ears Inc. has been in business for five years. At the end of each reporting period management uses the allowance method for estimating and recognizing bad debt expense. You have been hired to prepare the journal entry to recognize bad debt using management's estimate for this reporting period. Mouse Ears Inc.'s management provides you with the following information: Net sales of $5,250,000, accounts receivable of $820,000 and the allowance for doubtful accounts of $200,000. After management aged the receivables, they concluded that 25% of the $820,000 accounts receivable would not be collectible. Using the allowance method - What would the correct journal entry be to record / to recognize bad debt expense based on management's estimate?

A) Bad Debts Expense $205,000 Allowances for Doubtful Accounts $205,000
B) Bad Debts Expense $5,000 Allowance for Doubtful Accounts $5,000
C) No entry needs to be made

Answer 1

B) Bad Debts Expense $5,000 Allowance for Doubtful Accounts $5,000

Step-by-step explanation:

The allowance for doubtful accounts already has a $200,000 credit balance. Total bad debt for the year is estimated at $820,000 x 25% = $205,000. So the adjustment entry must increase the allowance for doubtful accounts account and bad debt account by $205,000 - $200,000 = $5,000. It should be:

December 31, 202x, adjustment to bad debt expense

Dr Bad debt expense 5,000

Cr Allowance for doubtful accounts 5,000

that way the ending balance of bad debt expense and the allowance for doubtful accounts will equal $200,000 + $5,000 = $205,000

Allowance for doubtful accounts is a contra asset account that reduces the balance of accounts receivable.