Multiple Choice
When an account becomes uncollectible and must be written off under the allowance method, which of the following is the correct journal entry?
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7. Receivables and Investments
Net Accounts Receivable: Allowance for Doubtful Accounts
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The percentage-of-receivables approach to measuring bad debt expense is referred to as:
A
the balance sheet approach
B
the direct write-off method
C
the aging of inventory method
D
the income statement approach
Verified step by step guidance1
Understand the concept of bad debt expense: Bad debt expense is the cost associated with accounts receivable that are unlikely to be collected. Companies estimate this expense to comply with the matching principle in accounting.
Learn about the percentage-of-receivables approach: This method estimates bad debt expense based on a percentage of the ending accounts receivable balance. It focuses on the balance sheet and ensures that the allowance for doubtful accounts is properly adjusted.
Compare the percentage-of-receivables approach to other methods: The direct write-off method records bad debt only when it is certain that a specific account will not be collected, which violates the matching principle. The aging of inventory method is unrelated to accounts receivable and bad debt expense, as it deals with inventory valuation. The income statement approach estimates bad debt based on a percentage of credit sales, focusing on the income statement rather than the balance sheet.
Recognize why the percentage-of-receivables approach is called the balance sheet approach: This method directly adjusts the allowance for doubtful accounts, which is a contra-asset account on the balance sheet, ensuring the accounts receivable are reported at their net realizable value.
Conclude that the correct answer is 'the balance sheet approach,' as this term accurately describes the percentage-of-receivables method for estimating bad debt expense.
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