Section 6 - Other End of Period adjustments Flashcards
What is the Allowance for Doubtful Accounts?
The amount of accounts receivable a company estimates it will never receive. Since it is doubtful, the company makes the following entry:
Bad Debt Expense (DR.)
Allowance for Doubtful Accounts (CR.)
When a company determines an account will not be collected, it is moved from the doubtful to the sure category and the company makes the following entry to permanently write off the account:
Allowance for Doubtful Accounts (DR.)
Accounts Receivable (CR.)
The direct write-off method is allowed under Generally Accepted Accounting Principles (GAAP).
True or False
False.
GAAP uses the allowance method when accounting for bad debt.
The direct write off method is used for tax purposes and is not permissible under GAAP rules.
What is residual (salvage) value?
The residual value often referred to as the salvage value, is an estimate of the resale value or how much an asset will be worth at the end of its useful life. The residual value is not depreciated as this is a portion of an asset’s cost that the company expects to recapture on its own.
To be depreciable, assets must meet the following three conditions:
- The asset must be tangible, such as a building, equipment or furniture. (Land is not depreciated)
- The asset cannot be held for resale or investment purposes.
- The asset must have a useful life of more than 1 year when acquired.
At the end of 20x8, your company has accounts receivable of $75,000, of which it estimates 11% will be bad debt.
If Allowance for Doubtful Accounts (ADA) has a debit balance of $3,200, what would be the 20x8 adjusting entry?
Bad Debt Expense (DR.) $11,450
Allowance for Doubtful Accounts (CR.) $11,450
When using the percentage of accounts receivable method, the estimate must become the ending balance in the ADA account. In this case, the ADA account has a debit, negative balance. The company’s estimate yields $8,250 ($75,000*11%). Since the ADA account has a debit balance of $3,200, this means the company underestimated bad debt. Therefore, in order to reestablish a credit balance, the company must record $11,450 in order to get the desired ending balance of $8,250 and account for the $3,200 that was written off for which a bad debt expense entry was not recorded.
When using the percentage of accounts receivable method, the estimated bad debt must become the ending balance in the ADA account. In this case, the company’s estimate yields $8,250 ($75,000*11%). Since the ADA account has a debit balance of $3,200, this represents a negative balance as the normal balance for the ADA account, a contra-asset account to Accounts receivable is a credit; therefore, in order to reestablish a credit balance, the company must record bad debt expense in the amount of $11,450 to get the desired ending balance of $8,250 and account for the $3,200 Accounts Receivable balance that was written off for which no estimate was made.
What type of account is Accumulated Depreciation?
Contra-asset account.
Accumulated depreciation is a contra account to a depreciating asset. Accumulated depreciation accounts for all depreciation recorded year to date for an asset.
The cost of the asset less the accumulated depreciation is the assets net book value.
For tax purposes, the direct write off method is used to account for bad debts.
True or False
True.
The direct write off method is required by the IRS and must be used when a company determines that a particular receivable will not be collected.
The direct write-off method is not permitted under GAAP.
If a company earned $60 in interest on their money market account, the year-end entry is:
Cash- Money Market $60
Interest Revenue $60
What is the net realizable value?
Accounts Receivable - Allowance for Doubtful Accounts
The net realizable value is the amount of Accounts Receivable the company ultimately expects to collect from customers. Much like the contra-asset account Accumulated Depreciation which reduces the book value of an asset, Allowance for doubtful accounts reduces the balance in accounts receivable.
ABC Co estimates bad debt as a percentage of accounts receivable. For the year A/R is $229,000 and management estimates 5% will be uncollectible.
If the Allowance for Doubtful Accounts (ADA) has a credit balance of $2,300, the adjusting entry for bad debt expense should be:
Bad Debt Expense $9,150
Allowance for Doubtful Accounts $9,150
When using the percentage of accounts receivable method, the estimated bad debt must become the ending balance in the ADA account. In this case, the company’s estimate yields $11,450 ($229,000*5%). Since the ADA account has a credit balance of $2,300, this represents a positive balance as the normal balance for the ADA account, a contra-asset account to Accounts receivable is a credit, therefore, to get the desired ending balance of $11,450, the company must record additional bad debt expense of $9,150.
Allowance for doubtful accounts always has a credit balance.
True or False
False.
Whenever a company confirms a receivable will not be collected, in order to write-off the account, the Allowance for Doubtful Accounts (ADA) is debited and the Accounts Receivable account is credited. If more accounts are written off than the company anticipated, constantly debiting the ADA account would result in a debit balance.
Whenever a company writes off more accounts than expected, a credit balance is reestablished when the company makes a new estimate at year-end.
Which of the following assets are not depreciated?
Furniture
Land
Building
Equipment
Inventory
Land and Inventory.
Land is never depreciated.
Inventory is not depreciated either; instead, it is valued using either the LIFO, FIFO, Specific Identification Method or Weighted Average Method.
What are the two methods used to record bad debt expense under GAAP?
When recording bad debt, GAAP permits the allowance method which allows the two following methods:
- Estimate of bad debt as a percentage of credit sales
- Estimate of bad debt as a percentage of accounts receivable
A piece of equipment costs $54,000 and has a residual value of $12,000. The asset is expected to last for 6 years.
The yearly depreciation expense using the straight-line method is:
Straight-line formula:
Depreciable base = (Cost-Residual Value)
Useful life in years
Depreciable Base $54,000 - $12,000 = $42,000*
$42,000* = $7,000 per year
6
At the end of 20x9, your company has accounts receivable of $80,000, of which it estimates 13% is uncollectible.
If Allowance for Doubtful Accounts (ADA) has a credit balance of $2,600, what is the 20x9 adjusting entry?
Bad Debt Expense $7,800
Allowance for Doubtful Accounts $7,800
When using the percentage of accounts receivable method, the estimated bad debt must become the ending balance in the ADA account. In this case, the company’s estimate yields $10,400 ($80,000*13%). Since the ADA account has a credit balance of $2,600, this represents a positive balance as the normal balance for the ADA account, a contra-asset account to Accounts receivable is a credit, therefore, to get the desired ending balance of $10,400, the company must record additional bad debt expense of $7,800. ($10,400-2,600 = $7,800)
Each year the balance in the Accumulated Depreciation account is increased.
True or False
True.
Every year depreciation expense is recognized for all depreciable assets. The general entry for Depreciation always a debits a Depreciation Expense account, increasing total expenses on the Income Statement and credits the associated Accumulated Depreciation increasing the balance in the account, ultimately reducing the book value of the asset on the Balance Sheet.
Depreciation Expense (DR)
Accumulated Depreciation (CR)
The adjusting entry to record depreciation expense debits Accumulated Depreciation.
True or False
False.
The general entry to record depreciation expense, no matter which method is used (Straight-line, Units of Production, Double declining balance) credits Accumulated Depreciation as follows:
Depreciation Expense (DR)
Accumulated Depreciation (CR)
When using straight-line depreciation, the formula is:
Straight-line formula:
Depreciable base = (Cost-Residual Value)
Useful life in years
If a company earns interest on an interest-bearing cash account, at year-end an adjusting entry must be made.
True or False
False.
Cash is NEVER adjusted, therefore such entries are recognized as normal transactional entries as opposed to adjusting entries.
Your firm estimates bad debt expense as 3% of credit sales, which was $299,000 for the year,
If the Allowance for Doubtful Accounts (ADA) has a debit balance of $2,970, what is the adjusting entry?
(Credit Sales x Estimated Uncollectible %) = $299,000*3% = $8,970
Bad Debt Expense (DR.) $8,970
Allowance for Doubtful Accounts (CR.) $8,970
Please note, under this method, the balance in the Allowance for Doubtful Accounts is IRRELEVANT. The balance in the ADA account is only relevant when a company uses the percentage of account receivable method.
The general entry to record depreciation is:
Depreciation Expense (DR)
Accumulated Depreciation (CR)
Depreciation expense, reported on the Income Statement, is the portion of a fixed asset that is considered consumed in the current period. The intent of recognizing depreciation is to gradually reduce the book value of fixed assets as they lose value as they’re used in the business.
Accumulated depreciation is a contra-asset account and reflects the total depreciation expense taken for a fixed asset since it was acquired and made available for use. As a contra-asset account, Accumulated depreciation has a normal credit balance and appears on the balance sheet. The balance in the account is subtracted from the original cost of the associated asset to determine the book value.
Under which method of accounting for bad debt expense is the balance in the Allowance for doubtful accounts irrelevant?
Percentage of Credit Sales method.
When companies use this method, in order to find the bad debt estimate, they simply multiply the percentage estimated to be uncollectible by the amount of credit sales.
For example, For 20x6, Mama Co has credit sales of $325,000. Based on past experience, the company estimated that bad debt for the year will be 3%. With no regard to the balance in the ADA account, at year-end, the adjusting journal entry will be:
Bad Debt Expense $9,750*
Allowance for Doubtful Accounts $9,750
($325,000 * 3% = $9,750)
What is depreciation?
Depreciation is the process of recapturing the cost of an asset. In essence, it is an accounting method used to allocate (spread) the cost of a tangible asset over its useful life to account for the decrease in value over time and allows a company to match the cost of the asset against the income it helps generates.
In order to find the depreciable base, the residual (salvage) value must be _____ (added/subtracted)
Subtracted - Depreciable base = Cost - Residual (Salvage) value
When calculating depreciation expense using the Straight-line method, the depreciable base must be used as the numerator and is found as shown above.
At the end of 20x6, your company has accounts receivable of $125,000, of which it estimates 9% will be uncollectible (bad debt)
If Allowance for Doubtful Accounts (ADA) has a credit balance of $5,600, what is the 20x6 adjusting entry?
Bad Debt Expense $5,650
Allowance for Doubtful Accounts $5,650
When using the percentage of accounts receivable method, the estimated bad debt must become the ending balance in the ADA account. In this case, the company’s estimate yields $11,250 ($125,000*9%). Since the ADA account has a credit balance of $5,600, this represents a positive balance as the normal balance for the ADA account, a contra-asset account to Accounts receivable is a credit, therefore, to get the desired ending balance of $11,250, the company must record additional bad debt expense of $5,650. ($11,250 - 5,600 = $5.650)
Your company estimates bad debt as a percentage of accounts receivable. A/R for the year is $149,000 and management estimates 7% will be uncollectible.
If the Allowance for Doubtful Accounts (ADA) has a debit balance of $1,100, the adjusting entry for bad debt expense should be
Bad Debt Expense $11,530
Allowance for Doubtful Accounts $11,530
When using the percentage of accounts receivable method, the estimated bad debt must become the ending balance in the ADA account. In this case, the company’s estimate yields $10,430 ($149,000*7%). Since the ADA account has a debit balance of $1,100, this represents a negative balance as the normal balance for the ADA account, a contra-asset account to Accounts receivable is a credit; therefore, in order to reestablish a credit balance, the company must record bad debt expense in the amount of $11,530 to get the desired ending balance of $10,430 and account for the $1,100 Accounts Receivable balance that was written off for which no estimate was made.
The allowance for doubtful accounts appears on which financial statement?
Balance sheet as a contra-asset account to Accounts Receivable.
If the company writes off more accounts receivables than estimated, this results in a debit balance in the Allowance for Doubtful Accounts.
True or False
True.
Perry Co estimates bad debt as a percentage of credit sales. The company had $305,000 in sales for the year, however, 6% is expected to be uncollectible. The allowance for doubtful accounts has a debit balance of $2,300.
At year-end, the adjusting entry for bad debt expense should be:
(Credit Sales x Estimated uncollectible %) - $305,000 x 6% = $18,300.
Bad Debt Expense $18,300
Allowance for Doubtful Accounts $18,300
Please note, when using the percentage of credit sales method, the balance in Allowance for Doubtful Accounts(ADA) is IRRELEVANT. The balance in the ADA account is only relevant when a company uses the percentage of account receivable method.
Bad debt expense appears on which financial statement?
Income Statement
If a company fails to record a journal entry for depreciation expense at year end, how are the financial statements be affected?
Balance Sheet I_ncome Statement_
Assets - Overstated Revenue - No Effect
Liabilities - No Effect Expenses - Understated
Net Income - Overstated
The formula to find the depreciable base is:
Cost - Residual (Salvage) value
The depreciable base is the maximum amount of depreciation that can be recognized for an asset.
A building is acquired at a cost of $110,000. It is estimated to have a 29-year useful life as has a residual value of $23,000.
The yearly depreciation expense using the straight-line method is
Straight-line formula:
Depreciable base = (Cost-Residual Value)
Useful life in years
Depreciable base $110,000 - $23,000 = $87,000*
$87,000 = $3,000 per year
29
Company E purchased a fixed asset with an original cost of $74,000, an estimated useful life of 4 years and a residual value of $4,000.
The journal entry to record depreciation in year 2 is:
Depreciable base = (Cost-Residual Value)
Useful life in years
Depreciable base = $74,000 - $4,000 = $70,000
$70,000 = $17,500 per year
4
Depreciation Expense $17,500
Accumulated Depreciation $17,500
