Direct Write-Off Method

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Assignment Question(s):​​​​​​(Marks 5)

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Q1. When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible.  As a result of this, a company must recognize bad debt expense.  There are basically two methods of recognizing bad debt expense: (1) direct write-off method, and (2) allowance method.

Instructions

(a)​Describe carefully both the direct write-off method and the allowance method of recognizing bad debt expense, give a numerical example with the journal entry for each method.  (1.5 marks)

(b)​Discuss the reasons why one of the above methods is preferable to the other and the reasons why the other method is not usually in accordance with IFRS.  (0.5 mark)

Q2. Presented below is financial information related to AbdallahCompany:

​Revenue​SAR950,000

​Comprehensive income​140,000

​Net income​105,000

​Income from operations​260,000

​Selling and administrative expenses​600,000

​Income before income tax​240,000

Compute the following: (a) other income and expense, (b) financing costs, (c) income tax, and (d) other comprehensive income.     (1 mark)

Q3. Ahmed Co. records purchase discounts lost (net method) and uses perpetual inventories.  Prepare journal entries in general journal form for the following:

(a)​Purchased merchandise costing SAR 1000 with terms 2/10, n/30.   (0.5 mark)

(b)​Payment was made thirty days after the purchase.  (0.5 mark)

Q4. The December 31, 2016 inventory of ABC Company consisted of four products, for which certain information is provided below.

​​​Estimated​Expected​

ProductOriginal Cost​​Completion CostSelling Price

​A​SAR25​SAR10​SAR40​

​B​SAR42​SAR20​SAR58​

​C​SAR120​SAR40​SAR150​

​D​SAR18​SAR5​SAR26​

Using the lower-of-cost-or-net realizable value approach applied on an individual-item basis, compute the inventory valuation that should be reported for each product on December 31, 2016.   (1 mark)

Q.1

Question a

The bad debts are the accounts receivable which are uncollectible. In direct write off method, the debts are written off as bad only when it is confident that the debt is irrecoverable which means the expense is recorded only when the bad debts are materialised.

In allowance method, the bad debt expenses are estimated as percentage of accounts receivable at the end of the year. The actual bad debts are written off against the allowance for doubtful debts when the bad debts are actually materialised.

For example:-

During the year one of debtor run away and Abdullah companycannot realise it’s balance of $5000 then the journal entry for this will be

Bad debts expense​ 5000

To Accounts receivables. ​5000

Question b

The direct write off method is easiest method to write off the bad debts. However, it has drawback. It violets the matching concept.The revenue from sales is recorded in one year and if the bad debts expenses are materialised in the next year, then expenses are charged in the next year. This is not correct as per the matching concept we need to recognise the expenses related to revenue in the same year in which year revenue is recognised.

In allowance method, the bad debts expenses are estimated based on percentage of accounts receivable balance at the end of the year and allowance for doubtful debt is created accordingly which means expenses are recognised in the year in which sales revenue is recognised.

Therefore, the allownace method is usually preferred for recognizing bad debt expenses.

For example:-

X company Estimates 1% of 500,000 sales revenue will not be collected, the journal entry will be

Bad debts expense 5000

To Allowance for bad debts     5000

(500,000*1%)

Q.2

Solution a:

Other Income = Income From Operation = 260,000

Other expense = Selling and administrative expenses = 600,000

Solution b:

Financing Costs = (Revenue – Selling and administrative expense) – Income before income tax

= (950,000 – 600,000) – 240,000 = 110,000

Solution c:

Income Tax = Income before income tax -Net income = 240,000 -105000 = 135,000

Solution d:

Dircontinued operations = Income From operations – Income from Continuing operations

= 260,000 -120,000 = 140,000

Solution e:

Other comprehensive income = Comprehensive income – Net income

= 140,000 – 105,000 = 35,000

Q.3

(A) up on purchase

Dr. Purchase 980

Cr. Creditors​​ 980

(Being goods purchased on credit)

(B) Upon payment

Dr. Creditors ​​​​980

Dr. Purchase discount forfeited​ 20

Cr. Cash ​​​  1,000

(Payment made to creditors and discount availed)

Q.4

Product      Original Cost      Completion Cost       Total cost          Net selling price

A                        $25                $10                      ​$35     ​​    $40

B                        $42                 $20                          $62                     $58

C                      $120                 $40                         $160                   $150

D                        $18                 $5                            $23                    $26

So, inventory will be valued at lower of cost and net realisablevalue

Product Total Cost ​Net Realisable value​​ Inventory to be valued

A $35​​​​ $40​​​​ $35

B $62​​​​ $58​​​​ $58

C $160​​​​ $150​​​​ $150

D $23​​​​  $26​​​​ $23

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