Question

Can someone please explain the answer to this? On multiple Quizlets the answer to this exact question is B. From my understanding, bad debt expense is computed from accounts receivable, which is why I am so confused.

Which of the following is a generally accepted method of determining the amount of the adjustment to the bad debt expense?

A. a percentage of sales adjusted for the balance in the allowance

B. a percentage of sales not adjusted for the balance in the allowance

C. a percentage of accounts receivable not adjusted for the balance in the allowance

D. an amount derived from aging accounts receivable and not adjusted for the balance in the allowance

Answer 1

Answer

• The correct answer is indeed Option B only.
• There are two method to calculate Bad Debt Expense when following Allowance method for Doubtful Account.

--Allowance method usage leads to creation of a separate contra asset account namely ‘Allowance for Doubtful Account’ which has a normal ‘credit’ balance.

--Bad Debt Expense is calculated (under allowance method) using two ways:

#1: Where Bad Debt Expense = Percentage of Credit Sale. Here, no concern is given to existing balance in ‘Allowance account’. Bad Debts expense is debited by the amount which equals to a certain percentage of Credit Sale, like 1 % of Sale.

#2: Where Bad Debt Expense = Difference between Adjusted balance of Allowance account “required” and Unadjusted balance of Allowance account existing. Here, first we calculate what should be the ‘adjusted’ credit balance of allowance account and then adjust Allowance account accordingly. This ‘adjusted’ credit balance of account can be calculated using aging of receivables.

• Hence, in short, adjustment to Bad Debt expense can be made either:
  #1 by calculating a % on sales (or credit sale) and recording the amount as Bad Debt Expense (without adjusting the balance in Allowance account),
  OR
  #2 by calculating a % on account receivables, and then adjusting it to the balance existing in Allowance account.
• Option B is correct because it is based on Way #1 mentioned above which states that % of sale = Bad Debt expense and No adjustment for the balance in allowance account.
  
• Option A is incorrect, because % of sales is NOT adjusted for the balance in allowance [Option says “adjusted”]
• Option C is incorrect, because % of account receivables IS ADJUSTED for the balance in the allowance [Options says “not”]
• Option D is incorrect, because amount derived from aging accounts receivables is also ADJUSTED for the balance in allowance.