The following illustration sets forth the method of handling bad debts on the books of account:
| Accounts Receivable | |||
| 19— | |||
| June 30 | 100,000.00 | ||
| Reserve for Doubtful Accounts | |||
| 19— | |||
| June 30 (A) | 2,000.00 | ||
| Bad Debts | |||
| 19— | 19— | ||
| June 30 (A) | 2,000.00 | June 30 Profit and Loss (B) | 2,000.00 |
| Profit and Loss | |||
| 19— | |||
| June 30 Bad Debts (B) | 2,000.00 | ||
It is known, from past experience, that the asset Accounts Receivable, $100,000 in this instance, will not be collected in full. To bring this book value down to its real value, the estimated loss, which it is thought will be 2% of the outstanding accounts, is reserved from their value, that is, credited to a reserve account, which is to be taken in conjunction with the asset account. The offsetting debit is to Bad Debts, an expense account. It represents an expense which the current period has to bear, and is closed into Profit and Loss with other expense accounts.
Handling Prepaid and Accrued Expenses and Income.—The method of handling the estimates or inventories of prepaid and accrued expenses and income is very similar to that shown for handling the mixed Merchandise account. Illustrations follow:
| Insurance | |||
| 19— | 19— | ||
| Jan. 1 (Paid) | 150.00 | June 30 (Unexpired) | 125.00 |
| Profit and Loss | 25.00 | ||
| 150.00 | 150.00 | ||
| June 30 (Deferred) | 125.00 | ||
| Rent Income | |||
| 19— | 19— | ||
| June 30 (Unearned) | 250.00 | June 15 (Received) | 300.00 |
| Profit and Loss | 50.00 | ||
| 300.00 | 300.00 | ||
| June 30 (Deferred) | 250.00 | ||
| Wages | |||
| 19— | 19— | ||
| June 30 (Paid) | 2,125.00 | June 30 Profit and Loss | 2,325.00 |
| (Accrued, unpaid) | 200.00 | 2,325.00 | |
| 2,325.00 | |||
| June 30 (Accrued) | 200.00 | ||
| Interest Income | |||
| 19— | 19— | ||
| June 30 Profit and Loss | 145.00 | June 30 (Received) | 127.50 |
| (Accrued, due us) | 17.50 | ||
| 145.00 | 145.00 | ||
| June 30 (Accrued) | 17.50 | ||
The first account, Insurance, shows the method of handling a deferred or prepaid expense. At the close of the period the account is a mixed account, the unexpired portion of the insurance representing an asset to be shown on the balance sheet as a deferred charge, the expired or consumed portion representing an expense for the period to be closed into Profit and Loss. Insurance has been paid, in this case for a three-year term; hence only one-sixth of it is chargeable to the first half-year, the remainder being deferred to later periods. The amount of the inventory or unexpired portion is entered to the credit of the account in order to effect subtraction of the amount, the balance of $25 thereby showing the insurance cost for the current period. This balance is carried to Profit and Loss. After closing the account, the inventory is entered to the debit side below the ruling, thus showing the so-called “deferred asset” portion which will appear in the balance sheet.
The next account, Rent Income, is a mixed account with income and liability elements. It shows that rent has been received for a period which extends beyond the current fiscal period. On June 15, rent for the period of, say, June 15 to September 15 was received. Only one-sixth of this income applies to the term January 1 to June 30; therefore the balance of $250 must be deferred or carried over to the next fiscal period. The adjustment is made by an entry of $250 for unearned rent on the debit side to effect its subtraction from the earnings for the current period, thus reducing them to $50. This income of $50 is transferred to the credit of the Profit and Loss account. After the Rent account is ruled off, the deferred income is entered below the ruling on the credit side, forming a part of the earnings of the next period. It is shown among the liabilities in the balance sheet for the current period, usually under the caption of “Deferred Income.”
The third account, Wages, shows wages paid to June 30 of $2,125. At that date wages earned but not yet paid, perhaps because the pay-day did not coincide with the date of closing the books, amounted to $200. This item is obviously an expense of the current period incurred during the short interval between the last pay-day in June and June 30. The adjustment is therefore made by entering $200 on the debit side of the Wages account, to effect the addition of this sum to the expense already shown there. The total amount of the account is transferred to Profit and Loss and the account is ruled off. The amount of unpaid wages, $200, is shown on the credit side beneath the ruling. In the balance sheet it appears as a liability, usually under the caption of “Accrued Expense.”
Similarly with the fourth account, Interest Income. Income to date is $127.50; earned but not yet due on June 30, $17.50, showing full earnings of $145 for the current period. This total is transferred to Profit and Loss, the account is ruled off, and the earned but not received portion is shown as a debit beneath the ruling, and as an asset in the balance sheet.
Great care must be exercised in the adjustment of all inventories to maintain the equilibrium of the ledger by the entry of each amount to both the debit and credit sides.