Problem 11 - Accounting

Question

Fonda Bikes Co. is a wholesaler of motorcycle supplies. An aging of the company's accounts receivable on December 31, 2010, and a historical analysis of the percentage of uncollectible accounts in each age category are as follows: \begin{tabular}{lrc} Age Interval & Balance & Percent Uncollectible \\ \hline Not past due & \(\$ 567,000\) & \(1 / 2 \%\) \\ \(1-30\) days past due & 58,000 & 3 \\ \(31-60\) days past due & 29,000 & 7 \\ \(61-90\) days past due & 20,500 & 15 \\ \(91-180\) days past due & 15,000 & 40 \\ Over 180 days past due & 10,500 & 75 \\ \cline { 2 - 3 } & \(\$ 700,000\) & \end{tabular} Estimate what the proper balance of the allowance for doubtful accounts should be as of December 31, 2010 .

Step-by-Step Solution

Answer

The proper balance of the allowance for doubtful accounts should be \( \$23,555 \).

Step 1: Calculate Uncollectible Amount for Not Past Due Accounts

The balance for accounts that are not past due is \( \\(567,000 \) with an uncollectible rate of \( 0.5\% \). To calculate the uncollectible amount, multiply the balance by the percentage: \[ 567,000 \times 0.005 = \\)2,835 \]

Step 2: Calculate Uncollectible Amount for 1-30 Days Past Due Accounts

The balance for accounts that are 1-30 days past due is \( \\(58,000 \) with an uncollectible rate of \( 3\% \). Multiply the balance by the percentage:\[ 58,000 \times 0.03 = \\)1,740 \]

Step 3: Calculate Uncollectible Amount for 31-60 Days Past Due Accounts

The balance for accounts that are 31-60 days past due is \( \\(29,000 \) with an uncollectible rate of \( 7\% \). Multiply the balance by the percentage:\[ 29,000 \times 0.07 = \\)2,030 \]

Step 4: Calculate Uncollectible Amount for 61-90 Days Past Due Accounts

The balance for accounts that are 61-90 days past due is \( \\(20,500 \) with an uncollectible rate of \( 15\% \). Multiply the balance by the percentage:\[ 20,500 \times 0.15 = \\)3,075 \]

Step 5: Calculate Uncollectible Amount for 91-180 Days Past Due Accounts

The balance for accounts that are 91-180 days past due is \( \\(15,000 \) with an uncollectible rate of \( 40\% \). Multiply the balance by the percentage:\[ 15,000 \times 0.40 = \\)6,000 \]

Step 6: Calculate Uncollectible Amount for Over 180 Days Past Due Accounts

The balance for accounts over 180 days past due is \( \\(10,500 \) with an uncollectible rate of \( 75\% \). Multiply the balance by the percentage:\[ 10,500 \times 0.75 = \\)7,875 \]

Step 7: Sum All Uncollectible Amounts to Find the Total Allowance

Sum the uncollectible amounts from each category to find the total allowance for doubtful accounts:\[2,835 + 1,740 + 2,030 + 3,075 + 6,000 + 7,875 = \$23,555\]

Key Concepts

Accounts Receivable

Accounts receivable represents the outstanding invoices a company has, or money that clients owe the company. Often, this is a result of sales made on credit with the understanding that the payment will be made at a later date. For a business like Fonda Bikes Co., accounts receivable could include payments due from distributors or retailers that are yet to be received for motorcycles supplies purchased.
Understanding accounts receivable is crucial for managing a business's cash flow effectively. They are listed as a current asset on the balance sheet because they are usually to be paid within a short time period. It's important to monitor these closely to ensure funds are available to meet the company’s obligations. Neglect in this area could lead to cash flow issues or worse, realizing losses on bad debts.

Uncollectible Accounts

Uncollectible accounts, also known as bad debts, are accounts receivable that cannot be collected. This happens when a customer isn't able to meet their payment obligations due to financial difficulties or other reasons. For companies like Fonda Bikes Co., estimating uncollectible accounts accurately is vital for financial planning.
Businesses often establish an allowance for doubtful accounts to anticipate potential losses from uncollectible accounts. This is an estimated amount set aside, usually based on past experience, to cover any receivables that may ultimately prove to be uncollectible. Regular review and adjustment of this allowance ensure it reflects the current risk of uncollectibility. This practice also ensures that the value of total accounts receivable more accurately reflects the amount expected to be received.

Aging Schedule

An aging schedule is a breakdown of accounts receivable according to the length of time invoices have been outstanding. This tool is crucial for assessing the credit risk associated with a company's client base. It categorizes receivables according to their age, such as 'not past due', '1-30 days past due', and further brackets as shown in the exercise above.
This schedule helps businesses like Fonda Bikes Co. to quickly identify overdue accounts and assess the likelihood of uncollectibility. By applying different uncollectible percentages to each bracket, the company creates a realistic estimate of the allowance for doubtful accounts. This structured insight aids decision-making, particularly regarding credit policies and collection strategies to minimize future uncollectible accounts.