CMA Part 1 Q&A – Bad Debt Expense Formula

CMA Exam Questions - bad debt expense formula

Student Question

“Please help me understand the answer with a solution before the journal entry.”

– Marco

MCQ

Madison Corporation uses the allowance method to value its accounts receivable and is making the annual adjustments at fiscal year end, November 30. The proportion of uncollectible accounts is estimated based on past experience, which indicates 1.5% of net credit sales will be uncollectible.

Listed below are Madison’s account balances at November 30 prior to any adjustments and the $10,000 write-off.

Sales
Accounts receivable  750,000
Sales discounts -125,000
Allowance for doubtful accounts -16,500
Sales returns and allowances -175,000
Bad debt expense 0

After a suggestion from the company’s external auditors, Madison wishes to value its accounts receivable using the balance sheet approach instead.

The chart below presents the aging of the accounts receivable subsidiary ledger accounts at November 30, not including the account to be written off.

Due <60 days 61-90 days 91-120 days >120 Total
$390,000 $115,000 $210,000 $25,000 740,000
1% 5% 15% 40%  % Uncollectible

The final entry to the related accounts is:

A. Credit allowance for doubtful accounts for $44,650 and debit bad debt expense for $44,650. (Correct Answer)
B. Debit allowance for doubtful accounts for $44,650 and credit bad debt expense for $44,650.
C. Debit allowance for doubtful accounts for $34,650 and credit sales for $34,650.
D. Credit accounts receivable for $34,650 and debit bad debt expense for $34,650.

1-on-1 CMA Coaching Support

LOS: Identify how various financial transactions affect the elements of each of the financial statements and determine the proper classification of the transaction.

COMPUTATION AND DISCUSSION:
The problem is basically requiring us to find the adjusting entry for the allowance for doubtful accounts (expense to be recognized). The problem states that it wishes to value its accounts receivable approach.
This means that the accounts receivable (a balance sheet account) will be the basis of the estimate of the allowance for doubtful accounts.

We will use the following formula in computing the expense to be recognized by squeezing it out:

Allowance for Doubtful Accounts Beginning xxx
Add: Expense Recognized for the Period (Bad Debt Expense for the Period) xxx
Less: Accounts Written Off (xxx)
Allowance for Doubtful Accounts, Ending (Required Balance) xxx

Replacing all with the given,

Allowance for Doubtful Accounts Beginning 16500
Add: Expense Recognized for the Period (Bad Debt Expense for the Period) ???
Less: Accounts Written Off 10,000
Allowance for Doubtful Accounts, Ending (Required Balance) xxx This is to be computed
using the aging of AR

Let us now compute the required balance of allowance for doubtful accounts using the accounts receivable as a basis (balance sheet approach):

($390,000 x 1%) 3,900
($115,000 x 5%) 5,750
($210,000 x 15%) 31,500
($25,000 x 40%) 10,000
Allowance for Doubtful Accounts, Ending (Required Balance) 51,150

Therefore, we can now squeeze out the equation to get the expense adjustment:

Allowance for Doubtful Accounts, Ending (Required Balance) 51,150
Add: Accounts Written Off 10,000
Less: Allowance for Doubtful Accounts Beginning 16,500
Expense Recognized for the Period (Bad Debt Expense for the Period) 44,650

The entry to record the adjustment will be:

DEBIT CREDIT
Bad Debt Expense 44,650
Allowance for Doubtful Accounts 44,650

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Until our next lesson,
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