At year end Dodgy Ltd had a balance in Accounts receivable of $40 000 and an Allowance for doubtful debts of $2 000. It was decided to write off as irrecoverable the debt of Houdini Ltd totalling $3 500. It was further decided that the Allowance for doubtful debts should stand at 10 per cent of Accounts receivable. What was the journal entry needed to bring the Allowance for doubtful debts to the required level after writing off the debt of Houdini Ltd?
A) DR Bad debts expense $4 000
CR Allowance for doubtful debts $4 000
B) DR Bad debts expense $5 150
CR Allowance for doubtful debts $5 150
C) DR Bad debts expense $5 500
CR Allowance for doubtful debts $5 500
D) DR Allowance for doubtful debts $3 500
CR Accounts receivable $3 500

Question

Quizplus · Accepted Answer

Before the write-off, the Allowance for doubtful debts was $2,000 which is 5% of the Accounts receivable balance of $40,000 (2,000/40,000 = 0.05). However, it is required to have the Allowance at 10% of the Accounts receivable balance. Therefore, the required balance for the Allowance for doubtful debts is $4,000 (10% x 40,000 = 4,000).

After the write-off of $3,500, the balance in Accounts receivable is reduced to $36,500 ($40,000 - $3,500). To adjust the Allowance for doubtful debts to the required level, the journal entry would be:

DR Bad debts expense $1,150 ($4,000 - $2,850)
CR Allowance for doubtful debts $1,150 ($4,000 - $2,850)

The difference between the required balance of the Allowance for doubtful debts and the current balance after the write-off ($4,000 - $2,850 = $1,150) is debited to Bad debts expense and credited to Allowance for doubtful debts. This brings the Allowance for doubtful debts account to the required balance of $4,000.

At Year End Dodgy Ltd Had a Balance in Accounts