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Assignment Method Of Estimating Bad

Intermediate Accounting: Assignment 7Doyle Problem 7-1: Recording Sales Gross and NetOn June 1, Bumgarner Company sold to Posey Company merchandise having a gross sale priceof $3,000 with terms of 2/10, n/30. Posey pays off $1,000 of the gross receivable on June 7 by paying $980 and receiving a $20 sales discount. Posey pays off the other $2,000 of the grossreceivable on June 30 by paying cash of $2,000 (no sales discount).(a) Show the 3 journal entries (June 1, June 7, and June 30) for Bumgarner Company, assumingthat Bumgarner uses the gross method.1-JunA/R: Posey (+A)3,000 Sales (+R)3,000 7-JunCash (+A)980 Sales Discount (+XR)20 A/R: Posey (-A)1,000 30-JunCash (+A)2,000 A/R: Posey (-A)2,000 (b) Show the 3 journal entries (June 1, June 7, and June 30) for Bumgarner Company, assumingthat Bumgarner uses the net method.1-JunA/R: Posey (+A)2,940 Sales (+R)2,940 7-JunCash (+A)980 A/R: Posey (-A)980 30-JunCash (+A)2,000 Sales Discounts Forfeited (+R)40 This is like interest revenueA/R: Posey (-A)1,960 (c) If Posey failed to pay any of the $3,000 within 10 days, it would lose the 2% discount of$60. What is the annual effective rate of interest for Posey for paying in 30 days instead ofpaying in 10 days? Hint: they are effectively paying $60 for an additional 20 days to pay.** Note that if Posey wants the discount, they will pay in 10 days. If they don't take thediscount, they have to pay in 30 days (or someone will break their legs). Therefore,the $60 gives them an extra 20 days to pay. The "principal" amount of the loan is thecash purchase price of $2,940.Interest cost for 20 days = $60 / $2,940 = 2.04%Interest cost on an annual basis = 2.04% * 365/20 = 37.24%

Accounts receivable aging is a technique to estimate bad debts expense by classifying accounts receivable of a business according to of length of time for which they have been outstanding and then estimating the probability of noncollection for each category. The classification of accounts receivable in the accounts receivable aging schedule also helps the business to identify the customers who take longer to pay so that they can restrict sales to those customers to reduce risk of bad debts.

Typically receivables are categorized into periods which are multiples of payment terms. For example if company sells at payment terms of n/20, the typical classification in aging schedule will be 0 to 20 days, 20 to 40 days, 40 to 60 days and so on.

The next step is to calculate the probability of noncollection for each of the above category which is then multiplied with the sum of accounts receivable from each category. This returns the amount of accounts receivable which are expected to become bad in each category. The sum of estimated noncollected accounts receivable from each category is fixed as the ending balance of allowance for bad debts account. Bad debts expense is calculated as provided in percentage of receivables method of bad debts estimation.

Example

Age CategoryAmountProbability of NoncollectionUncollectible Amount
1-20 days$64,2002%$1,284
20-40 days11,9004%476
40-60 days5,2007%364
60-80 days35012%42
   $2,166

Written by Irfanullah Jan