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Bad Debts expense and the Allowance account are different

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As the accountant for Pure-Air Distributing, you attend a sales managers meeting devoted to a discussion of credit policies. At the meeting, you report that Bad Debts expense is estimated to be $59,000 and Accounts Receivable at year amount to be $1,750,000, less a $43,000 allowance for Doubtful accounts. Sid Omar, a sales manager, expresses confusion over why Bad Debts expense and the allowance for Doubtful accounts are different amounts.

Write a one-page memorandum to him explaining why a difference in Bad Debts expense and the allowance for Debt Doubtful accounts is not unusual. The company estimates bad debt expense as 2% of sales.

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Solution Summary

The 367-word solution provides an easy-to-understand explanation of why the expense account will not usually agree with the allowance account. Even sales people can probably get it.

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The purpose of this memo is to clarify and explain the accounting treatment with respect to the allowance for doubtful accounts.

In accrual accounting, we always attempt to match costs to revenue in the period in which they are incurred or earned. Based on past history we know that 2% of total sales will probably result in bad debts. That percentage could be modified by a review of credit policies, and it could change from time to time depending on market conditions and credit policies.

At this point, 2% has been judged to be ...

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