CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsMedium
A company uses the allowance method for uncollectible accounts. At year-end, the company's accounts receivable balance is $500,000, and the allowance for doubtful accounts has a debit balance of $5,000 before adjustment. If the company estimates that 3% of accounts receivable will be uncollectible, what is the amount of bad debt expense to be recognized?
- A$5,000
- B$20,000
- C$10,000
- D$15,000
Show answer & explanationAnswer & explanation
Correct answer: B. $20,000
The required allowance balance is 3% of $500,000, which is $15,000. Since the allowance account currently has a debit balance of $5,000, the bad debt expense needed to reach the credit balance of $15,000 is $15,000 + $5,000 = $20,000.
Why the other options are wrong
- A. This is the existing debit balance, not the bad debt expense.
- C. This incorrectly subtracts the debit balance from the target, or assumes a credit balance.
- D. This is the target ending balance for the allowance, not the bad debt expense.
Allowance Method for Bad Debts
The allowance method estimates uncollectible accounts receivable and records bad debt expense in the same period as the related revenue, ensuring proper matching.
- Estimates uncollectible accounts.
- Creates an Allowance for Doubtful Accounts (contra-asset).
- Recognizes Bad Debt Expense through an adjusting entry.
Memory trick: Receivables are a PROMISE, but sometimes the PROMISE is BROKEN.