Question

(Bad-Debt Reporting) The chief accountant for Dickinson Corporation provides you with the following list of accounts receivable written off in the current year.

Date	Customer	Amount \(
March 31	E.L Masters Company	\)7,800
June 30	Stephen Crane Associates	6,700
September 30	Amy Lowell’s Dress Shop	7,000
December 31	R. Frost. Inc	9,830

Dickinson follows the policy of debiting Bad Debt Expense as accounts are written off. The chief accountant maintains that this procedure is appropriate for financial statement purposes because the Internal Revenue Service will not accept other methods for recognizing bad debts.

All of Dickinson’s sales are on a 30-day credit basis. Sales for the current year total \(2,200,000. The balance in Accounts Receivable at year-end is \)77,000 and an analysis of customer risk and charge-off experience indicates that 12% of receivables will be uncollectible (assume a zero balance in the allowance).

Instructions

(a) Do you agree or disagree with Dickinson’s policy concerning recognition of bad debt expense? Why or why not?

(b) By what amount would net income differ if bad debt expense was computed using the percentage-of-receivables approach?

Short answer

Net income under the percentage method of calculating bad debt will be higher by$22,090.

Step-by-step solution

Definition of Direct Write Off Method

The method of reporting uncollectible amount under which a business entity directly debits bad debt expenses and credit accounts receivables is known as direct write-off method.

Justification of method used

Direct write-off method is not theoretically correct because it does not follow the matching principle of accounting. It does not report the accounts receivables in their net realizable value. Therefore, a business entity must not adopt direct write-off method.

Difference in net income when percentage method is used

Particular	Amount $
Direct write off method$\left(\$7,800+\$6,700+\$7,000+\$9,830\right)$	$31,330
Less: Percentage of receivables $\left(\$77,000\times 12\%\right)$	($9,240)
Difference in net income	$22,090