Ask Me Help Desk - Ratio Calculations and Doubtful Accounts

I am working on a homework problem where I have been given an income statement and balance sheet along with additional data that states: The year-end balance in the allowance for doubtful accounts was $3,000 for 2009 and $2,400 for 2008.

Instructions
Compute the following ratios for 2009.

(a) Current. (h) Return on common stockholders’ equity.
(b) Acid-test. (I) Earnings per share.
(c) Receivables turnover. (j) Price-earnings.
(d) Inventory turnover. (k) Payout.
(e) Profit margin. (l) Debt to total assets.
(f) Asset turnover. (m) Times interest earned.
(g) Return on assets.

In computing ratios will the year end balance in the allowance for doubtful accounts affect the ratio calculations?

We are NOT allowed to answer homework
Questions.

What kind of account is allowance for doubtful accounts?

Go to each of those questions (which I assume have been given to you in your book or in notes) and see if that kind of account would affect that equation.

Quote:

Originally Posted by ROLCAM

We are NOT allowed to answer homework
questions.

I apologize I guess I wasn't really clear the homework assignment is to calculate ratios. I know how the formulas and how to calculate the ratios. I am seeking guidance in correctly interpreting the given information to calculate the ratios. My question was: "In computing ratios will the year end balance in the allowance for doubtful accounts affect the ratio calculations?" We have not covered doubtful accounts in class, but I don't like to assume that it is not relevant because we have not covered it in class.

From what I have since read in the text I know that a doubtful account is used in the allowance method of accounting for bad debts. When companies write off a specific account, they debit actual uncollectibles to the allowance for doubtful accounts and credit that amount to accounts receivable. What is not clear, is if this is done before or after the amounts are put on the balance sheet? If the purpose of this is to provide better matching on the income statement and to ensure that companies state receivables on the balance sheet at their cash (net) realizable value, if accounts receivables is reported at its net value on the balance have these doubtful accounts already been accounted for?

What is not clear, is if this is done before or after the amounts are put on the balance sheet?

The balance day adjustments are usually done
Before the finalizing of the Profit and Loss
Account and certainly before the drawing of the FINAL Balance Sheet.

Quote:

Originally Posted by zetablue1

From what I have since read in the text I know that a doubtful account is used in the allowance method of accounting for bad debts. When companies write off a specific account, they debit actual uncollectibles to the allowance for doubtful accounts and credit that amount to accounts receivable. What is not clear, is if this is done before or after the amounts are put on the balance sheet? If the purpose of this is to provide better matching on the income statement and to ensure that companies state receivables on the balance sheet at their cash (net) realizable value, if accounts receivables is reported at its net value on the balance have these doubtful accounts already been accounted for?

ALL entries will be done before putting anything on financial statements. Those statements are a reporting of the final numbers. If you do anything after that, it would only be to catch up your ledger account to stuff you've done on a worksheet or something similar. But the amounts on the statements are already the final correct ones. If there were any final entries needing done (like income tax), you'd still have to have that done to get all the proper balances to use for the statements.

You actually have a much better understanding of this concept than I've seen out of most people. :) The amount in the allowance account on the balance sheet is an estimated amount to be used for write-off's in the future. So while all entries have already been, it's a matter of when those entries are being done. The actual write-off you speak of would be done at various times during the year when you decide to write off an actual account. Then at the end of the year, an adjusting entry is done to bring back up the allowance account to what you think it ought to currently be. By time you're doing statements, all those entries have been done, the last being the adjusting entry.

In the end, it's not really relevant to the question. It's asking if the balance in the allowance account would affect those ratios. It doesn't matter what the balance is - it's only asking if that balance is affecting those ratios.

So what you really need to know is the allowance is a contra asset account, which reduces the receivables and as you seem to already know, creates the net value of receivables. For the computations, just keep in mind that it's reducing receivables.

For the very last question, since they are referring to the allowance account only, all you have to think about is whether it affects anything included in the ratio. Since it's a (contra) current asset, it'll affect anything that includes current assets. It'll also affect anything including receivables. (And further, anything that includes total assets also, etc.) Don't worry about what went into or out of that account, nor what happened to the income statement. You cannot tell from the info given what the expense was, and it only asks if the balance of that account affects the ratio.

Thanks for your help. When the class actually covers doubtful accounts I will be a step ahead.