Under both bases the company must determine its past

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Survey of Accounting
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Chapter 3 / Exercise E3-10
Survey of Accounting
Warren
Expert Verified
Under both bases, the company must determine its past experience with bad debtlosses.Percentage-of-Sales.In the percentage-of-sales basis, management esti-mates what percentage of credit sales will be uncollectible.This percentage is basedon past experience and anticipated credit policy.The company applies this percentage to either total credit sales or net creditsales of the current year.To illustrate, assume that Gonzalez Company elects to usethe percentage-of-sales basis. It concludes that 1% of net credit sales will becomeuncollectible. If net credit sales for 2011 are $800,000, the estimated bad debtsexpense is $8,000 (1% $800,000).The adjusting entry is:364Chapter 8Accounting for ReceivablesDec. 31Bad Debts Expense8,000Allowance for Doubtful Accounts8,000(To record estimated bad debts for year)After the adjusting entry is posted, assuming the allowance account already hasa credit balance of $1,723, the accounts of Gonzalez Company will show thefollowing:This basis of estimating uncollectibles emphasizes the matching of expenseswith revenues.As a result, Bad Debts Expense will show a direct percentage rela-tionship to the sales base on which it is computed.When the company makes theadjusting entry, it disregards the existing balance in Allowance for DoubtfulAccounts.The adjusted balance in this account should be a reasonable approxi-mation of the realizable value of the receivables. If actual write-offs differ signifi-cantly from the amount estimated, the company should modify the percentage forfuture years.Percentage-of-Receivables.Under the percentage-of-receivables basis,management estimates what percentage of receivables will result in losses fromuncollectible accounts. The company prepares an aging schedule, in which itclassifies customer balances by the length of time they have been unpaid.Because of its emphasis on time, the analysis is often called aging the accountsreceivable. In the opening story,Whitehall-Robinsprepared an aging reportdaily.After the company arranges the accounts by age, it determines the expectedbad debt losses. It applies percentages based on past experience to the totals ineach category.The longer a receivable is past due, the less likely it is to be collected.Thus, the estimated percentage of uncollectible debts increases as the numberof days past due increases. Illustration 8-7 shows an aging schedule for DartCompany. Note that the estimated percentage uncollectible increases from 2 to40% as the number of days past due increases.Bad Debts ExpenseAllowance for Doubtful AccountsDec. 31 Adj.8,000Jan.1 Bal.1,723Dec. 31 Adj.8,000Dec. 31 Bal.9,723Illustration 8-6Bad debts accounts afterpostingCash Flowsno effectASEL8,000 Exp8,000JWCL165_c08_356-395.qxd 7/31/09 3:20 PM Page 364
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Survey of Accounting
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Chapter 3 / Exercise E3-10
Survey of Accounting
Warren
Expert Verified
Total estimated bad debts for Dart Company ($2,228) represent the amount ofexisting customer claims the company expects will become uncollectible in thefuture. This amount represents the required balancein Allowance for DoubtfulAccounts at the balance sheet date.The amount of the bad debt adjusting entry

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