Emma's Clothes, Inc. has accounts receivable of $210,000. In the current economy, she has noticed an increase in uncollectible accounts. In 2016, her sales were $3,200,000 and in 2017, sales were $3,800,000. She has estimated in the past that 2% of sales would eventually be uncollectible. Emma believes that her losses were closer to 3% last year. She has recorded bad debt expense of 2% for 2017
Does she need to make a retroactive correction for 2016, and should she add an additional adjustment to 2017? If so, write the journal entry for the year-end adjustment.
What will be an ideal response?
Answer: Estimates frequently need to be adjusted for changes in the business environment. Emma should not make any adjustment for 2016 because the estimate was made in good faith relying on information at that time. Neither should she make an additional change from 2016 during 2017. If Emma believes that the best rate for 2017 is 3%, she should record a journal entry to increase the 2017 estimate of 2% to 3% of 2017 sales.
The journal entry for December 31, 2017 to adjust the estimated expense is:
Debit
Credit
Bad Debt Expense
38,000
Allowance for Bad Debts
38,000
$3,800,000 × 1% additional equals $38,000.
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