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Information related to Hermesch Company for 2008 is summarized below.
Total credit sales \$2,200,000
Accounts receivable at December 31 825,000

(a) What amount of bad debts expense will Hermesch Company report if it uses the direct writeoff method of accounting for bad debts?

(b) Assume that Hermesch Company estimates its bad debts expense to be 2% of credit sales.
What amount of bad debts expense will Hermesch record if it has an Allowance for Doubtful Accounts credit balance of \$4,000?

(c) Assume that Hermesch Company estimates its bad debts expense based on 6% of accounts receivable. What amount of bad debts expense will Hermesch record if it has an Allowance for Doubtful Accounts credit balance of \$3,000?

(d) Assume the same facts as in (c), except that there is a \$3,000 debit balance in Allowance for Doubtful Accounts.What amount of bad debts expense will Hermesch record?

(e) What is the weakness of the direct write-off method of reporting bad debts expense?

#### Solution Preview

(a) What amount of bad debts expense will Hermesch Company report if it uses the direct write-off method of accounting for bad debts?

Under the direct write-off method, bad debts are accounted for when they are determined to be uncollectible. Therefore, Hermesch Company would report \$33,000 in bad debts expense, the amount it wrote off in the current year.

(b) Assume that Hermesch Company estimates its bad debts expense to be 2% of credit sales.
What amount of bad debts expense will Hermesch record if it has an Allowance for Doubtful Accounts credit balance of \$4,000?

Under the allowance method, the Allowance for Doubtful Accounts, a contra-account to Accounts Receivable, is adjusted based upon estimated bad debts for the year and for actual bad debts for the year. In the current case, the company is using an income statement approach; that is, it is recording bad debts expense based upon credit sales made during the year. Therefore, the Hermesch Company will record a bad debts expense of \$2,200,000*.02, or ...

#### Solution Summary

Given a company's total credit sales, accounts receivable at December 31, and bad debts written off, this solution answers the following questions:

(a) What amount of bad debts expense will the company report if it uses the direct writeoff method of accounting for bad debts?

(b) If the company estimates its bad debts expense to be a percentage of credit sales, what amount of bad debts expense will it record if it has an Allowance for Doubtful Accounts with a credit balance?

(c) If the company estimates its bad debts expense to be a percentage of credit sales, what amount of bad debts expense will it record if it has an Allowance for Doubtful Accounts with a debit balance?

(d) What is the weakness of the direct write-off method of reporting bad debts expense?

\$2.49