Problem 4 - Accounting

Question

Journalize the following transactions in the accounts of Food Unlimited Company, a restaurant supply company that uses the allowance method of accounting for uncollectible receivables: Jan. 18. Sold merchandise on account to Wings Co., \(\$ 13,200\). The cost of the merchandise sold was \(\$ 9,500\). Mar. 31. Received \(\$ 5,000\) from Wings Co. and wrote off the remainder owed on the sale of January 18 as uncollectible. Sept. 3. Reinstated the account of Wings Co. that had been written off on March 31 and received \(\$ 8,200\) cash in full payment.

Step-by-Step Solution

Answer

The journal entries include recognizing the sale, partial payment and write-off, reinstatement of the account, and final payment by Wings Co.

Step 1: Journalize the Sale on Account

On January 18, record the sale of merchandise on account to Wings Co. The entry recognizes the revenue from the sale and the related cost of goods sold. Debit Accounts Receivable - Wings Co. $13,200 Credit Sales Revenue $13,200 Also, record the cost of merchandise sold: Debit Cost of Goods Sold $9,500 Credit Inventory $9,500

Step 2: Record Partial Payment and Write-off

On March 31, record the cash received from Wings Co. and the write-off of the remaining balance. First, record the payment received: Debit Cash $5,000 Credit Accounts Receivable - Wings Co. $5,000 Then, write off the remaining balance as uncollectible: Debit Allowance for Doubtful Accounts $8,200 (13,200 - 5,000) Credit Accounts Receivable - Wings Co. $8,200

Step 3: Reinstate Written-off Balance

On September 3, before recording the received cash, the account previously written off must be reinstated. Reverse the write-off entry: Debit Accounts Receivable - Wings Co. $8,200 Credit Allowance for Doubtful Accounts $8,200

Step 4: Record Cash Received after Reinstatement

Now, with the account reinstated, record the cash received in full payment of the account: Debit Cash $8,200 Credit Accounts Receivable - Wings Co. $8,200

Key Concepts

Allowance Method

The allowance method in accounting is a way to handle uncollectible receivables by estimating and recording potential losses from bad debts. This method is widely accepted as it adheres to the matching principle, ensuring that the expenses are recorded in the same period as the revenue they are related to. By predicting uncollectible accounts, businesses can account for potential losses right away, rather than waiting until a specific account is deemed uncollectible.

Using journal entries, businesses establish an account known as the "Allowance for Doubtful Accounts." This account is a contra-asset account, meaning it reduces the total amount of accounts receivable reported on the balance sheet. When a debt is written off, it is done against this allowance, so the direct impact on profits is spread out over time, following the initial estimation.

Accounts Receivable

Accounts receivable is the accounting term for the money that is owed to a company by its customers for goods or services delivered on credit. These are considered assets because they represent a future inflow of cash. Additionally, they demonstrate a company's ability to generate revenue from sales on credit.

In journal entries, when a sale on credit is made, the company records a debit to accounts receivable, increasing this asset. When payment is received, a credit entry reduces the balance. This ledger balances by matching sales revenue, helping manage cash flow expectations and financial health indicators.

Uncollectible Receivables

Uncollectible receivables refer to debts that a company does not expect to collect from its customers. These accounts need to be accounted for as they can impact the financial standing of a business. With the allowance method, companies estimate these potential losses and prepare for them ahead of time, incorporating expected bad debts into financial statements.

When an account is deemed uncollectible, it is written off against the allowance for doubtful accounts previously set up. However, if the account is later paid, like in the case of Wings Co., it can be reinstated, reversing the write-off. This flexibility helps maintain accurate financial records and cash flow predictions.

Cost of Goods Sold

Cost of goods sold (COGS) represents the direct costs attributable to the production of goods sold by a company. This figure includes the cost of the materials and labor directly used to create the goods and excludes indirect expenses like distribution and sales force costs.

In accounting, COGS is critical as it directly impacts gross profit on the income statement. The entry is made when sales occur, typically debiting COGS and crediting Inventory. This process ensures that the financial statements accurately reflect the cost associated with revenue in the same reporting period, providing a clear picture of profit margins and operational efficiency.