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Allowance for Doubtful Accounts Two Methods

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Also see attached MS Word document titled Ethan Company Problem.

At December 31, 2011 Ethan Company reports the following results for its calendar year

Cash sales $1,803,750
Credit sales 3,534,000

In addition, its unadjusted trial balance includes the following items/

Accounts receivable $1,070,100 Debit
Allowance for doubtful accounts 15,750 Debit

1. Prepare the adjusting entry for the company to recognize bad debts under each of the following independent assumptions (Round your answers to the nearest dollar amount. Omit the "$" sign in your response.)
a. Bad debts are estimated to be 2% of credit sales.
b. Bad debts are estimated to be 1% of total sales.
c. An aging analysis estimates that 5% of year-end accounts receivable are uncollectible.
2. Show how accounts Receivable and the Allowance for Doubtful Accounts appear on its December 31, 2011, balance sheet given the facts in part 1a, b, and c. (Amounts to be deducted should be indicated with a minus sign. Omit the "$" sign in your response.

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Solution Summary

This solution is comprised of a detail explanation of two methods of estimating allowance for doubtful accounts. Both percentage of sales and percentage of accounts receivable basis are the focus of the solution. An attached MS Word document contains examples along with easy to understand step-by-step information and related calculations.

Solution Preview

Also see the attached MS Word document titled Ethan Company Solution for correctly formatted information.

Valuing account receivables involves reporting receivables at their cash (net) realizable value. Cash (net) realizable value is the net amount the company expects to receive in cash. It excludes amounts that the company estimates it will not collect. This method reduces receivables in the balance sheet by the amount of estimated uncollectible receivables from credit sales. Credit losses are a normal and necessary risk of doing business on a credit basis. Uncollectible accounts may be recognized under the allowance method or by the direct write-off method. GAAP requires the allowance method for financial reporting purposes when bad debts are material in amount. Under this method companies estimate uncollectible accounts receivable and match this estimated expense against revenues in the same accounting period in which they record the revenues. Companies debit estimated uncollectibles to Bad Debts Expense and credit them to Allowance for Doubtful Accounts (a contra asset account) through an adjusting entry at the end of each period.

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