Which Accounts Are Affected, And In Which Direction, By The Following Business Transaction? A Customer Whose Account Was Written Off Two Years Ago Sends You A Cheque

Which Accounts Are Affected, And In Which Direction, By The Following Business Transaction? A Customer Whose Account Was Written Off Two Years Ago Sends You A Cheque. 1. Bad debt expense increases 2. Sales revenue increases 3. Sales revenue decreases 4. Bad debt expense decreases 5. Cash decreases 6. Allowance for doubtful accounts decreases 7. Allowance for doubtful accounts increases 8. Accounts receivable decreases 9. Cash increases 10. Accounts receivable increases
The correct options of this multiple choice question depends upon the Methods used in recording the Bad Debts Account. So, we must consider these two methods before choosing the correct options.

Under Direct Write-Off Approach, the company does not make an estimation of unpaid dues while under Allowance Approach, the company makes an estimation of uncollectible accounts / unpaid invoices by debited uncollectible expense a/c and credited Allowance for Doubtful Accounts.

When it is sure that the customer failed to pay to company for the goods or services rendered, then the company debit actual Bad Debts Expense a/c and credit Accounts Receivable (AR) a/c under Direct Write-Off Method while under Allowance Method, debit Allowance for Doubtful Accounts and credit accounts receivable a/c.

After two years, now as the customer is making payment to the company for goods sold or services rendered to him by the company, then there is Bad Debts Recovery.

Under Direct Write-Off Method, two journal entries are recorded as shown below:

(i) Reinstate AR (Reversing The Write-Off Entry)

                           Accounts Receivable a/c   XXX

                                                                   Bad Debts Expense a/c  XXX

                                                         (Reversing Entry Recorded)

(ii) Receipt of Cash Recorded

                                                     Cash a/c  XXX

                                                                  AR a/c  XXX

                                                  (Cash Received From Customer)

The effects of this transactions are that, cash increases and bad debts expense a/c decreases while there is no effect on AR, sales revenues and allowance for doubtful accounts under Direct Write-Off Method. So, the correct options are 4 and 9.

Under Allowance Method, two journal entries are recorded as show below:

(i) Reinstate the AR and Adjust the Allowance Balance

                                        AR a/c  XXX

                                              Allowance for Doubtful Accounts a/c  XXX

                       (Reversing Entry Recorded And Allowance Balance Adjusted)

(ii) Cash Received From Customer By Cheque

 

                                                  Cash a/c  XXX

                                                                  AR a/c XXX

                                                (Collected Cash From Customer)

Under allowance method, the effects of this transaction on accounts are that cash increases while allowance for doubtful accounts decreases as now the payment is made from customer. AR has no effect. Sales Revenue, Bad Debts expense a/c are not affected by this transaction. So, the correct options are 6 and 9.

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