Which of the following statements is true regarding the two allowance approaches used to estimate bad debts?

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BlackTom AI · Accepted Answer

Turning to the topic of bad debt estimation methods, each option makes a claim about how these approaches use or interact with the allowance account.
Option 1: 'The percentage-of-receivables approach takes into account the existing balance in the allowance for bad debts account.' This is accurate because the percentage-of-receivables (or aging) method estimates bad debt expense based on outstanding receivables and adjusts the allowance for bad debts to reflect the desired ending balance, thereby incorporating the existing allowance balance into the calculation.
Option 2: 'The percentage-of-sales approach takes into account the existing balance in the allowance for bad debts account.' This is not correct. The percentage-of-sales method estimates bad debt expense as a percentage of credit sales and typically ignores the current balance in the allowance account, focusing on income statement impact rather than adjusting the existing allowance balance.
Option 3: 'The direct write-off method takes into account the existing balance in the allowance for bad debts account.' The direct write-off method does not use an allowance account at all; it writes off bad debts only when a specific account is determined to be uncollectible, so there is no ongoing allowance balance to consider.
Option 4: 'The direct write-off method does a better job of matching revenues and expenses.' This statement is incorrect because the direct write-off method recognizes bad debt expense only when a specific account is deemed uncollectible, which can distort the timing of expense recognition and generally yields a poorer matching of revenues and expenses compared with the allowance methods.
In summary, only Option 1 accurately describes the interaction between the percentage-of-receivables approach and the existing allowance balance, while the other options misstate how the methods relate to the allowance account or the matching of revenues and expenses.

BACC012 Week 5: Practice Quiz

Which of the following statements is true regarding the two allowance approaches used to estimate bad debts?

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