Question

Part 1: On July 1, 2017, Wallace Company, a calendar-year company, sold special-order merchandise on credit and received in return an interest-bearing note receivable from the customer. Wallace Company will receive interest at the prevailing rate for a note of this type. Both the principal and interest are due in one lump sum on June 30, 2018.

Instructions

When should Wallace Company report interest revenue from the note receivable? Discuss the rationale for your answer.

Part 2: On December 31, 2017, Wallace Company had significant amounts of accounts receivable as a result of credit sales to its customers. Wallace uses the allowance method based on credit sales to estimate bad debts. Past experience indicates a reliable estimate of uncollectible accounts can be developed based on an aging analysis of receivable balances. This pattern is expected to continue.

Instructions

(a) Discuss the rationale for using the allowance method based on the balance in the trade receivables accounts.

(b) How should Wallace Company report the allowance for doubtful accounts on its balance sheet at December 31, 2017? Also, describe the alternatives, if any, for presentation of bad debt expense in Wallace Company’s 2017 income statement.

Short answer

Part 1: Accrued interest will be reported on 31 Dec 2017 for six months, and principle and remaining interest will be recognized on maturity.

Part 2:The allowance method does not overstate the accounts receivables of the business entity.

Step-by-step solution

Definition of Administrative Expenses

The sacrifices made by the business entity in the functions that are not considered as core functions of the business are known as administrative expenses.

Part 1

Since the company is acalendar-year company, the financial year-end of 31 December each year, in the above case, the business entity will accrue 6-months interest on the note at year-end on 31 Dec 2017. The remaining interest for six months will be recognized when collected on 30 June 2018. Rationale: The business entity will use the accrual method of accounting as it provides more reliable and useful information than cash accounting.

Part 2

(a) Rationale: The allowance method of recognizing bad debt complies with the matching principle's accounting principle. It tries to calculate the net realizable value of the accounts receivables and reports thebad debt expenses in the year in which the company's credit quality decreases. It is done using the aging schedule of the receivables and considering the bad debt expenses and adjustments that will bring the allowance account balance to the required balance.

(b) The company will report the allowance account on the balance sheet as a contra asset account and will be deducted from the accounts receivables under the current asset section. The bad debt expenses must be reported as other selling and administrative expenses in theincome statement. Sometimes it is deducted from the sales, same as discount and returns, and sometimes it is reported as finance expense.