(Bad-Debt Reporting Issues) Clark Pierce conducts a wholesale merchandising busi

Question

(Bad-Debt Reporting Issues)

Clark Pierce conducts a wholesale merchandising business that sells approximately 5,000 items per month with a total monthly average sales value of $250,000. Its annual bad debt rate has been approximately 1½% of sales. In recent discussions with his bookkeeper, Mr. Pierce has become confused by all the alternatives apparently available in handling the Allowance for Doubtful Accounts balance. The following information has been presented to Pierce.

1.An allowance can be set up (a) on the basis of a percentage of receivables or (b) on the basis of a valuation of all past due or otherwise questionable accounts receivable. Those considered uncollectible can be charged to such allowance at the close of the accounting period, or specific items can be charged off directly against (1) Gross Sales or to (2) Bad Debt Expense in the year in which they are determined to be uncollectible.

2.Collection agency and legal fees, and so on, incurred in connection with the attempted recovery of bad debts can be charged to (a) Bad Debt Expense, (b) Allowance for Doubtful Accounts, (c) Legal Expense, or (d) Administrative Expense.

3.Debts previously written off in whole or in part but currently recovered can be credited to (a) Other Revenue, (b) Bad Debt Expense, or (c) Allowance for Doubtful Accounts.

Instructions

Which of the foregoing methods would you recommend to Mr. Pierce in regard to (1) allowances and charge-offs, (2) collection expenses, and (3) recoveries? State briefly and clearly the reasons supporting your recommendations.

Explanation / Answer

Bad debts from uncollectible accounts is an expense for the business. This should be recorded in the books in the same period, in which the sales revenue is recorded. This is required to match the revenue with the expense. It is therefore advisable to provide for bad debts by creating an allowance for uncollectible accounts, and actual bad debts should be written off from this account.

This allowance can be estimated by analysis of each account, or as percentage to gross / net sales or as percentage of Accounts receivable (period wise)

Collection agency charges for recovery of bad debts should be charged to Legal expense or Administrative expense as per the decision of the management.

Debts previously written off in whole or in part but currently recovered should be credited to:

i)                    In case of direct write-off

First credit to Bad Debt Expense by debit to Accounts receivable, and then debit to cash and credit to Accounts receivable

ii)                  In case of Allowance method

First credit to Allowance for Doubtful Accounts by debit to Accounts receivable, and then debit to cash and credit to Accounts receivable

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