CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A company is reviewing its allowance for doubtful accounts. At year-end, Accounts Receivable totals $500,000, and the existing credit balance in the Allowance for Doubtful Accounts is $2,000. Based on an aging schedule, the company estimates that $27,000 of its accounts receivable will be uncollectible. What is the amount of Bad Debt Expense the company should recognize for the year?
- A$25,000
- B$27,000
- C$29,000
- D$50,000
Show answer & explanationAnswer & explanation
Correct answer: A. $25,000
When using the allowance method based on an aging schedule (or percentage of receivables), the estimated uncollectible amount represents the required ending balance in the Allowance for Doubtful Accounts. Bad Debt Expense is then the amount needed to adjust the allowance to this required balance.
Why the other options are wrong
- B. This represents the desired ending balance in the allowance account, not the expense for the period.
- C. This incorrectly adds the existing credit balance to the desired balance.
- D. This is an arbitrary number and does not reflect proper calculation.
Bad Debt Expense (Allowance Method)
Under the allowance method, bad debt expense is recognized based on an estimate of uncollectible accounts. The expense amount is the adjustment needed to bring the Allowance for Doubtful Accounts to its desired ending balance.
- Estimated uncollectible amount is the target ending balance for the allowance.
- Bad Debt Expense = Target Allowance Balance - Existing Allowance Balance (credit).
- If existing allowance has a debit balance, it is added to the target balance.
Memory trick: ALLOWANCE is the TARGET, EXPENSE is the ADJUSTMENT.