Problem 3 - Accounting

Question

Journalize the following transactions in the accounts of Laser Tech Co., a medical equipment company that uses the direct write-off method of accounting for uncollectible receivables: Feb. 23. Sold merchandise on account to Dr. Judith Salazar, \(\$ 41,500\). The cost of the merchandise sold was \(\$ 22,300\). May 10. Received \(\$ 10,000\) from Dr. Judith Salazar and wrote off the remainder owed on the sale of February 23 as uncollectible. Dec. 2. Reinstated the account of Dr. Judith Salazar that had been written off on May 10 and received \(\$ 31,500\) cash in full payment.

Step-by-Step Solution

Answer

1. February 23: Record sale and costs. 2. May 10: Record payment and write-off. 3. December 2: Reinstate account and receive payment.

Step 1: Record the Sale on Account

On February 23, record the sale of merchandise to Dr. Judith Salazar for $41,500. Since the sale is on account, we'll increase Accounts Receivable and Sales. The cost of goods sold, $22,300, also needs to be recorded by increasing Cost of Goods Sold and decreasing Inventory. Journal Entry: - Debit Accounts Receivable $41,500 - Credit Sales $41,500 - Debit Cost of Goods Sold $22,300 - Credit Inventory $22,300

Step 2: Record Partial Payment and Write-off

On May 10, Dr. Judith Salazar paid $10,000. Record this payment by reducing Accounts Receivable and increasing Cash. Write off the remaining balance of $31,500, considered uncollectible, by decreasing Accounts Receivable and increasing Bad Debt Expense. Journal Entry: - Debit Cash $10,000 - Credit Accounts Receivable $10,000 - Debit Bad Debt Expense $31,500 - Credit Accounts Receivable $31,500

Step 3: Reinstate the Account and Receive Full Payment

On December 2, reinstate the account of Dr. Judith Salazar that was previously written off. This involves reversing the write-off by increasing Accounts Receivable and decreasing Bad Debt Expense. After reinstating, record the receipt of the full payment of $31,500 by increasing Cash and decreasing Accounts Receivable. Journal Entries: 1. Reinstate: - Debit Accounts Receivable $31,500 - Credit Bad Debt Expense $31,500 2. Payment: - Debit Cash $31,500 - Credit Accounts Receivable $31,500

Key Concepts

Direct Write-Off Method

The Direct Write-Off Method is a straightforward way to handle uncollectible receivables, often used by businesses when an account is confirmed to be unpayable. Instead of estimating bad debts, this method waits until a specific account is identified, and it's certain that the customer isn't going to pay. This makes it different from other methods that predict bad debts and adjust accounts accordingly.

In this approach:

• No bad debt expense is recorded until a customer account is specifically identified as uncollectible.
• This can lead to fluctuations in reported income because expenses are not matched to revenues in the same period.
• It is simple and easy to apply, making it favorable for small businesses.

However, the method might not provide an accurate representation of financial health, as the "bad debt" expense impacts might not align correctly with the income generated from sales.

Uncollectible Receivables

Uncollectible receivables represent the amounts that a company determines it will not be able to collect from its customers. These amounts arise after customers fail to pay their debts, positively identified through defaults or bankruptcy actions.

When dealing with uncollectible accounts:

• Companies need to make a decision about how to account for these unpaid debts. This is important in maintaining clear and accurate financial records.
• The direct write-off method directly impacts income statements since the expense related to the uncollectible account is taken when the account is written off.
• Businesses utilize the direct write-off method often when the amounts are immaterial or when financial standards permit simplicity over precision.

Understanding how uncollectible receivables affect a business’s financial statements is crucial for managerial oversight and financial forecasting.

Accounts Receivable

Accounts receivable refer to the outstanding invoices that customers have yet to pay, representing money owed to a company. These are typically results of credit sales and are recorded as current assets in financial statements.

Key aspects of accounts receivable include:

• They help businesses maintain steady cash flow as customers pay their bills over time.
• Proper management ensures that companies don't face liquidity issues, which is crucial for operations and growth.
• In the journalizing process, entries affect accounts when transactions such as sales or payments are made, showing up as debits when sales occur and credits when payments are made.

The efficiency in managing accounts receivable reflects directly on a business's financial health and operational efficacy.

Bad Debt Expense

Bad debt expense is an unavoidable part of doing business, representing the cost associated with accounts that become uncollectible. It shows up on the income statement as an expense, reducing overall profit.

Considerations when accounting for bad debt expense:

• In the direct write-off method, a business only records a bad debt expense when a specific account is deemed uncollectible.
• This can lead to a mismatch in timing between revenue recognition and the related expense.
• While it simplifies the process for small businesses with infrequent uncollectible accounts, it might not conform to more stringent accounting standards like GAAP.

Understanding bad debt expense helps in making informed assessments about financial performance and resource allocation.