On December 31,2010 Carme Company had significant amounts of accounts receivable

Question

On December 31,2010 Carme Company had significant amounts of accounts receivables as a result of credit sales to its customers. Carme Company use the allowance method based on credit credit sales to estimate bad debts. based on past experience 1% of credit sales normally will not be collected. this pattern is expected to continue. Required: (1) Explain the rationale of using the allowance method based on credit sales to estimate bad debts. Contrast this method with the allowance method based on the balance in the trade receivable account.(2) Explain how Carme Company should report the allowance for bad debts account on its balance sheet at December 31,2010. Also describe the alternatives, if any, for presentation of bad debt expense in Carme Company's 2010 income statement.

Explanation / Answer

Under the allowance method, if a specific customer's accounts receivable is identified as uncollectible, it is written off by removing the amount from Accounts Receivable. The entry to write off a bad account affects only balance sheet accounts: a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable. No expense or loss is reported on the income statement because this write-off is "covered" under the earlier adjusting entries for estimated bad debts expense.

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