CA7-4Part_IISolution - expense is determined in the same...

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CA 7-4 Part 2 (a) The use of the allowance method based on credit sales to estimate bad debts is consistent with the expense recognition principle because bad debts arise from and are a function of making credit sales. Therefore, bad debt expense for the current period should be matched with current credit sales. This is an income statement approach because the balance in the allowance for doubtful accounts is ignored when computing bad debt expense. The allowance method based on the balance in accounts receivable is not consistent with the expense recognition principle. This method attempts to value accounts receivable at the amount expected to be collected. The method is facilitated by preparing an aging schedule of accounts receivable and plugging bad debt expense with the adjustment necessary to bring the allowance account to the required balance. Alternatively, the ending balance in accounts receivable can be used to determine the required balance in the allowance account without preparing an aging schedule by using a composite percentage. Bad debt
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Unformatted text preview: expense is determined in the same manner as when an aging schedule is used. However, neither of these approaches associates bad debt expense with the period of sale, especially for sales made in the last month or two of the period. (b) On Wallace’s balance sheet, the allowance for doubtful accounts is presented as a contra account to accounts receivable with the resulting difference representing the net accounts receivable (i.e., their net realizable value). Bad debt expense would generally be included on Wallace’s income statement with the other operating (selling/general and administrative) expenses for the period. However, theoretical arguments can be made for (1) reducing sales revenue by the bad debts adjustment in the same manner that sales returns and allowances and trade discounts are considered reductions of the amount to be received from sales of products or (2) classifying the bad debts expense as a financial expense....
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