CP 9-2 For several years, Xtreme Co.’s sales have been on a “cash only” basis. O
ID: 2450980 • Letter: C
Question
CP 9-2
For several years, Xtreme Co.’s sales have been on a “cash only” basis. On January 1 2013, however Xtreme Co. began offering credit on terms of n/30. The amount of the adjusting entry to record the estimated uncollectable receivables at the end of each year has been ½ of 1% of credit sales, which is the rate reported as the average for the industry. Credit sales and the year-end credit balances in Allowance for doubtful Accounts for the past four years are as follows:
Year
Credit sales
Allowance for doubtful accounts
2013
4000000
5000
2014
4400000
8250
2015
4800000
10200
2016
5100000
14400
Laurie Jones, President of Xtreme Co., is concerned that the method used to account for and write off uncollectible receivables is unsatisfactory. She has asked for your advice in the analysis of past operations in this area and for recommendations or change.
Determine the amount of (a) the addition to Allowance of Doubtful Accounts hand (b) the accounts written off for each of the four years.
A. Advise Laurie Jones as to whether the estimate of ½ of 1% of credit sales appears reasonable.
B. Assume that after discussing (a) with Laurie Jones, she asked you what actions might be taken to determine what the balance of Allowance for Doubtful Accounts should be at December 31, 2016, and what possible changes, if any, you might recommend in accounting for uncollectible receivables. How would you respond?
Year
Credit sales
Allowance for doubtful accounts
2013
4000000
5000
2014
4400000
8250
2015
4800000
10200
2016
5100000
14400
Explanation / Answer
Answer:(a)&(b)
Answer:A. The estimate of 1/2 of 1% of credit sales may be too large, since the allow-ance for doubtful accounts has steadily increased each year. The increasing balance of the allowance for doubtful accounts may also be due to the failure to write off a large number of uncollectible accounts. These possibilities could be evaluated by examining the accounts in the subsidiary ledger for collectibility and comparing the result with the balance in the al- lowance for doubtful accounts.
Answer:B. The balance of Allowance for Doubtful Accounts that should exist at December 31, 2016, can only be determined after all attempts have been made to collect the receivables on hand at December 31, 2016. However, the account balances at December 31, 2016, could be analyzed, perhaps using an aging schedule, to determine a reasonable amount of allowance and to determine accounts that should be written off. Also, past write-offs of uncollectible accounts could be analyzed in depth in order to develop a reasonable percentage for future adjusting entries, based on past history. Caution, however, must be exercised in using historical percentages. Specifically, inquiries should be made to determine whether any significant changes between prior years and the current year may have occurred, which might reduce the accuracy of the historical data. For example, a recent change in credit-granting policies or changes in the general economy (entering a recessionary period, for example) could reduce the usefulness of analyzing historical data.
Based on the preceding analyses, a recommendation to decrease the annual rate charged as an expense may be in order (perhaps Filet Co. is ex- periencing a lower rate of uncollectibles than is the industry average), or perhaps a change to the ¡ estimate based on analysis of recei vables ¢ method may be appropriate.
Year Credit sales Addition to Allowance for D/A Accounts written off during the year 2013 4000000 10000 5000 10000-5000 2014 4400000 11000 7750 11000-8250+5000 2015 4800000 12000 10050 12000-10200+8250 2016 5100000 12750 8550 12750-14400+10200