MODULE 7F

The Accounting Cycle of the Process - Summarizing Phase (Adjusting the Books)

DOUBTFUL ACCOUNTS EXPENSE

▪ Doubful Accounts is
▪ the possible portion of customers' account or credit sales that may not be collected at the end of the accounting period or at the time
the financial statements will be prepared.
▪ based only on estimate as a percentage either of accounts receivable (customers' accounts) or credit sales.
▪ is an expense in accordance with matching principle in which the related estimated uncollectible accounts during the accounting
period must be deducted from revenues generated during the same accounting period.
▪ also called uncollectible accounts expense.
▪ also called bad debts but bad debts in other countries like in UK means accounts that are proven to be uncollectible and subject to
write off in accounting books.

▪ Two method of accounting for Doubtful Accounts

1) Allowance method
▪ The acceptable method for financial accounting purposes.
▪ Not acceptable for tax purposes
▪ This used the account "Allowance for Doubtful Accounts"

2) Direct write-off method

▪ The acceptable method for tax purposes.
▪ Not acceptable for financial accounting purposes
▪ This will be discussed in intermediate accounting part 1

▪ Doubtful accounts rate

▪ The doubtful accounts rate is an estimated rate based on past experience of the business and will be studied and approved by
management.
a) Accounts proven uncollectible of past years are totalled and divided by outstanding accounts receivable at the end of past year or
divided by credit revenues (like sales).
b) The amount of accounts proven uncollectible of past years is net of accounts collected but thought to be uncollectible (accounts
recovered).

▪ Accounts affected by adjusting journal entry:

1) Doubtful Accounts Expense (DAE)
▪ an income statement account
▪ a nominal account
▪ can be classfied either of the following:
a) Distribution cost or selling expenses
▪ if provision was approved by the sales department
b) Administrative cost or general and administrative expenses
▪ if provision was approved by officers other than from sales department
▪ this is the normal classification if the problem is silent

2) Allowance for Doubtful Accounts (ADA)

▪ a statement of financial position or balance sheet account
▪ a real account
▪ a contra asset account because it is a deduction from the accounts receivable.

Amount Normal Balance

Accounts Receivable xxx Debit
Less: Allowance for Doubtful Accounts xxx Credit
Net realizable value (NRV) xxx

Notes:
The net realizable value (NRV) may also be called as follows:
a) Cash realizable value of accounts receivable
b) Carrying value or carrying amount of accounts receivable
c) Amortized cost of account receivable
▪ Pro-forma adjusting journal entry:

Doubtful accounts expense xxx

Allowance for doubtful accounts xxx

▪ Doubtful accounts rate

▪ It is based on past experience of the company by considering the actual accounts receivable proven uncollectible that are written off
from the accounting records. This is called the accounts written off.
▪ On the contrary, there are previously accounts written off but recovered the collection from customers. This is called recovered
account previously written off or simply recoveries.

▪ The actual bad debts or the net write-off to be used as basis to determine doubtful accounts rate is the difference between the two.
Net write-off = Accounts written off - Recoveries

▪ Actual bad debts rate can be computed by dividing the net write off either to:
a) Accounts receivable
b) Credit sales

▪ Basis of computation of doubtful accounts expense

a) Based on accounts receivable
▪ This is called the balance sheet or the statement of financial position approach.
▪ This is the most reliable basis in determining doubtful accounts expense at the end of the reporting period.
▪ Steps in computing doubtful accounts expense based on accounts receivable:
1) Multiply the doubtful accounts rate to outstandig account receivable balance at year end or based on aging of accounts
receivable. For basic accounting purposes, the basis to be used is the outstanding accounts receivable at the end of the
2) The amount computed in number 1 is the required pr adjusted allowance for Doubtful Accounts at the end of the reporting
period.

3) The doubtful accounts expense can be computed as follows:

Case 1 - There is unadjusted Allowance for Doubtful Accounts balance
Allowance for Doubtful Accounts, adjusted/required
(Accounts Receivable balance at end of reporting date x DA rate) xxx
Less: Allowance for Doubtful Accounts, unadjusted xxx
Doubtful Accounts Expense for the year (provision for DAE) xxx

Case 2 - There is no unadjusted Allowance for Doubtful Accounts balance

Doubtful accounts expense = AR balance at end of reporting date x DA rate

OR

Allowance for Doubtful Accounts, adjusted/required

(Accounts Receivable balance at end of reporting date x DA rate) xxx
Less: Allowance for Doubtful Accounts, unadjusted 0 This is ZERO
Doubtful Accounts Expense for the year (provision for DAE) xxx

b) Based on credit revenues

▪ This is based on credit Service Revenues for service business or Credit Sales Revenue for trading business.
▪ This is called the income statement approach.
▪ This is in accordance with matching principle of accounting because doubtful accounts expense is based on revenues.
▪ The doubtful accounts expense is computed as follows:
Doubtful accounts expense = Credit Revenues for the accounting period x DA rate
 EXERCISES
EXERCISE 1
Concept of Doubtful Accounts
State whether the following statements are TRUE or FALSE. Write your answer on the space provided before each number. Use only CAPITAL
LETTERS.

FALSE 1. Doubtful accounts represent proven and identified uncollectible accounts of customers arising from accounts receivable.
FALSE 2. Doubtful accounts are estimated uncollectible accounts that must be written off from accounting books.
FALSE 3. Doubtful accounts are related to both accounts receivable and notes receivable.
TRUE 4. The acceptable method of accounting for doubtful accounts is the allowance method.
FALSE 5. The direct write-off method is an acceptable method of accounting for doubtful accounts for financial accounting purposes.
FALSE 6. The allowance method is an acceptable method of accounting for doubtful accounts for tax purposes.
TRUE 7. If the account Allowance for doubtful accounts is existing in the accounting books, this means the entity is using the
allowance method of accounting for doubtful accounts.
TRUE 8. The doubtful accounts can be computed as a percentage of credit revenue or accounts receivable balance.
FALSE 9. The doubtful accounts rate is determined and estimated by management based on his own personal basis.
TRUE 10. Doubtful accounts expense can be classIfied as selling expense if determined and approved by sales department officer.
TRUE 11. Doubtful accounts expense can be classified in the income statement either as selling or administrative expense at the
discretion of the accounting department.
TRUE 12. Allowance for doubtful account is a contra-asset account.
TRUE 13. Allowance for doubtful account is deducted from accounts receivable.
TRUE 14. Accounts receivable less allowance for doubtful accounts equals net realizable value of accounts receivable.
TRUE 15. Net realizable value of accounts receivable is also called cash realizable value.
TRUE 16. Net realizable value of accounts receivable is also called amortized cost.
FALSE 17. Doubtful accounts expense based on sales is computed by multiplying doubtful accounts rate by accounts receivable.
FALSE 18. Outstanding accounts receivable balance times doubtful accounts rate equals doubtful accounts expense.
TRUE 19. The required or adjusted balance of the Allowance for Doubtful Accounts is equal to outstanding accounts receivable times
doubtful accounts rate.
TRUE 20. The difference between the required and the unadjusted allowance for doubtful accounts balances is the amount of the
doubtful accounts expense.
FALSE 21. The adjusting journal entry for doubtful accounts expense provision is debit allowance for doubtful accounts and credit
doubtful accounts expense.
TRUE 22. The normal balance of Allowance for Doubtful Accounts is credit.
TRUE 23. Any increase in allowance for doubtful accounts expense is credit.
FALSE 24. Doubtful accounts expense based on sales violates the matching principle.
FALSE 24. Doubtful accounts expense based on accounts receivable is in accordance with matching principle.
EXERCISE 2
Provision for Doubtful Accounts Based on Sales
At December 31, 2022, Marcus Trading presented the following accounts in its unadjusted trial balance:

Debit Credit
Accounts Receivable 1,550,000
Allowance for Doubtful Accounts 20,000
Sales 5,000,000
Sales Returns and Allowances 25,000
Sales Discounts 5,000

REQUIRED:
1) Prepare the necssary adjusting journal entry at December 31, 2022 assuming that doubtful accounts expense is:
a) 1/2% of gross sales.
b) 1% of net sales.

Case 1: DAE is 2% Gross Sales Case 2: DAE is 3% of Net Sales

Date Account Names Debit Credit Account Names Debit Credit
2022
Dec. 31

2) What is the adjusted balance of Allowance for Doubtful Accounts at December 31, 2022 for both cases? Support your answer by using T-
account for Allowance for Doubtful Accounts.

CASE 1 CASE 2

Allowance for Doubtful Accounts Allowance for Doubtful Accounts

3) Determine the net realizable value of accounts receivable at December 31, 2022 using the two cases in number 1.
SOLUTION GUIDE:
CASE 1 CASE 2
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net realizable value
EXERCISE 3
Provision for Doubtful Accounts Based on Accounts Receivable
At December 31, 2022, Tarcius Trading Company presented the following accounts in its unadjusted trial balance:

Debit Credit
Accounts Receivable 2,000,000
Allowance for Doubtful Accounts 3,000
Sales 5,000,000

REQUIRED:
1) Compute the doubtful accounts expense at December 31, 2022 assuming that the allowance for doubtful accounts should be:
a) 1/4% of outstanding accounts receivable at year-end.
b) 1% of outstanding accounts receivable at year-end.

2) Prepare the necssary adjusting journal entry at December 31, 2022 based on the two assumptions in number (1).
SOLUTION GUIDE:
Case 1: 1/4% of AR outstanding at year end Case 2: 1% of AR outstanding at year end
Date Account Names Debit Credit Account Names Debit Credit
2022
Dec. 31

3) Post the transactions in the general ledger for Doubtful Accounts Expense and Allowance for Doubtful Accounts.
SOLUTION GUIDE:

CASE 1: Allowance for Doubtful Accounts Doubtful Accounts Expense

CASE 2: Allowance for Doubtful Accounts Doubtful Accounts Expense

4) Compute the net realizable value of Accounts Receivable at December 31, 2022 using the two assumptions.
SOLUTION GUIDE:
CASE 1 CASE 2
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net realizable value
EXERCISE 4
Provision for Doubtful Accounts
At December 31, 2022, Hilarius Trading Company presented the following accounts in its unadjusted trial balance:

Debit Credit
Accounts Receivable 1,500,000
Allowance for Doubtful Accounts 1,000
Sales 5,000,000

REQUIRED:
1) Compute the doubtful accounts expense at December 31, 2022 based on the following assumptions:
a) The allowance for doubtful accounts is increased by P 1,500.
b) The allowance for doubtful accounts is increased to P 3,000.
2) Compute the adjusted allowance for doubtful accounts at December 31, 2022 based on the given assumptions in number 1.
3) Compute the cash realizable value of accounts receivable at December 31, 2022 based on the given assumptions in number 1.
SOLUTION GUIDE:
CASE 1 CASE 2
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net realizable value