Question

Manilow Corporation operates in an industry that has a high rate of bad debts. Before any year-end adjustments, the balance in Manilow’s Accounts Receivable account was \(555,000 and Allowance for Doubtful Accounts had a credit balance of \)40,000. The year-end balance reported in the balance sheet for Allowance for Doubtful Accounts will be based on the aging schedule shown below.

Days Account Outstanding	Amount	Probability of Collection
Less than 16 days	$300,000	.98
Between 16 and 30 days	100,000	.90
Between 31 and 45 days	80,000	.85
Between 46 and 60 days	40,000	.80
Between 61 and 75 days	20,000	.55
Over 75 days	15,000	.00

Instructions

(a) What is the appropriate balance for Allowance for Doubtful Accounts at year-end?

(b) Show how accounts receivable would be presented on the balance sheet.

(c) What is the dollar effect of the year-end bad debt adjustment on the before-tax income?

Short answer

1. Total allowance for doubtful accounts: $60,000.

2. Net accounts receivables: $495,000.

3. Dollar effect: $20,000.

Step-by-step solution

Definition of Allowance for Doubtful accounts

The contra-asset account that gets adjusted against the gross receivables of the business entity is known as allowance for doubtful accounts. It is calculated as an estimated percentage of gross receivables or credit sales.

Balance in allowance for doubtful accounts

Days Account Outstanding	Amount	Probability of Collection	Probability of uncollectible	Amount of uncollectible
Less than 16 days	$300,000	.98	0.02	$6,000
Between 16 and 30 days	100,000	.90	0.10	10,000
Between 31 and 45 days	80,000	.85	0.15	12,000
Between 46 and 60 days	40,000	.80	0.20	8,000
Between 61 and 75 days	20,000	.55	0.45	9,000
Over 75 days	15,000	.00	100	15,000
Total allowance for doubtful accounts				$60,000

Representation of accounts receivables on the balance sheet

Particular	Amount $
Accounts receivables	$555,000
Less: Total allowance for doubtful accounts	(60,000)
Net accounts receivable	$495,000

Dollar effect of year-end bad debt adjustments on before-tax income

Particular	Amount $
Estimated allowance for doubtful accounts	$60,000
Less: Credit balance in the allowance for doubtful accounts	(40,000)
Dollar effect on before tax income	$20,000