Estimating Bad Debts
Response to the following problem:
An examination of the accounting records of the Keegan Corporation disclosed the following information for 2010:
Cash sales $680,000
Net credit sales 527,000
Accounts receivable (12/31/10) 190,000
Allowance for doubtful accounts (12/31/10, prior to adjustment) 1,500 (debit)
Keegan wishes to examine the effect of various alternative bad debt estimation policies.
Required:
1. Prepare the adjusting entry that would be required under each of the following methods:
a. Bad debts are estimated at 1.4% of total sales (net).
b. Bad debts are estimated at 3% of net credit sales.
c. Bad debts are estimated at 7.5% of gross accounts receivable.
d. An aging of accounts receivable indicates that half of the outstanding accounts will incur a 3% loss, a quarter will incur a 6% loss, the remaining quarter will incur a 20% loss.
2. Discuss the difference between the income statement and balance sheet approaches to estimating bad debts.