Question

Installment Jewelry Company has been in business for 5 years but has never had its financial statements audited. Engaged to audit them for 2019, you find that the company’s balance sheet carries no allowance for bad accounts. Bad accounts have been expensed as written-off and recoveries credited to income as collected. The company’s policy is to write off at December 31 of each year those accounts on which no collections have been received for three months. The installment contracts generally are for 2 years.

On your recommendation, the company agrees to revise its accounts for 2019 to give effect to bad account treatment on the allowance basis. The allowance is to be based on a percentage of credit sales that is derived from the experience of prior years. Statistics for the past 5 years are shown in the following table:

Year of Sale	Credit Sales	Accounts Written Off					Recoveries
		2015	2016	2017	2018	2019
2015	$100,000	$550	$1,000	$1,050
2016	250,000		1,000	4,000	$2,400		$100
2017	300,000			1,300	13,000	$2,700	400
2018	157,500				1,500	5,000	500
2019	192,500					1,400	600

Accounts receivable at December 31, 2019, were as follows:

2018 credit sales	$15,000
2019 credit sales	135,000
	$150,000

	Required:
	Prepare the adjusting journal entry or entries with appropriate explanations to set up the Allowance for Bad Accounts.

General Journal

Prepare the adjusting journal entry or entries to set up the Allowance for Doubtful Accounts on December 31, 2019.

PAGE 10

GENERAL JOURNAL

	DATE	ACCOUNT TITLE	POST. REF.	DEBIT	CREDIT
1
2
3

Answer 1

2015 - percentage of write offs - 1000 + 1050+550 = 2600/100000 = 2.6%

2016 - (1000 + 4000+ 2400)-100 = 7300/250000 = 2.92%

2017 = (1300+13000 +2700)-400 = 16600/300000 = 5.5%

So average write off for the last three years is (2.6+2.92+5.5)/3 = 3.67%

Hence for FY 2018 & 2019 company should maintain Bad debt provision of 3.67%

Adjusting entries

31st Dec 2019 Receivable Debit 1400

Profit and Loss 1400

Being the write off done in FY 2019 reversed.

31st Dec 2019 Profit and Loss 600

Receivable 600

Being the recovery for FY 2019 posted to the receivable account.

31st Dec 2019 Profit and Loss (bad Debt provision) DR 5,505

Bad Debt Provision (Liability) Cr 5,505

working

150,000*3.67% = 5,505