Use the following information to answer the next two questions: Harris Company uses the allowance method of handling its credit losses. It estimates credit losses at 1.5% of credit sales, which were $2,700,000 during the year. On December 31, the Accounts Receivable balance was $475,000, and the Allowance for Doubtful Accounts had a balance of $30,600 before adjustment. Indicate the effect (increase / decrease) that recording the bad debt expense for the year will have on the company's assets, liabilities, and equity, respectively. Assets Liabilities+ Equity Select one:

a. Decrease, No Change, Decrease
b. Increase, No Change, Decrease
c. Increase, No Change, Increase
d. Decrease, Decrease, No Change
e. Increase, Decrease, Increase

a. Decrease, No Change, Decrease

Explanation:

This can be explained as follows

New Allowance for Doubtful Accounts = $2,700,000 × 1.5% = $40,500

Increase in Allowance for Doubtful Accounts = $40,500 - $30,600 = $9,900

The increase in the Allowance for Doubtful Accounts will reduce the Accounts Receivable balance by $9,900 because it will be added to the Allowance for Doubtful Accounts balance of $30,600 and affect Accounts Receivable as follows:

Accounts Receivable balance on December 31 after adjustment = $475,000 – ($30,600 + $9,900) = $434,500.

The increase of $9,990 in Allowance for Doubtful Accounts will decrease Accounts Receivable which an asset, and will also reduce equity because the $9,900 will be used to reduce the earning or retained earning which is an equity item. This does not and will not have any effect on the liability item.

Therefore, correct option is Decrease in asset, No Change in liabilities, Decrease in equity.

a)Decrease, No Change, Decrease

b) -Correct Answer is Option 'B' $ 403,900

--Workings

Accounts receivables, gross  $475,000

Less:  

Allowance account unadjusted balance$30,600  

Bad Debt Expenses [2700000 x 1.5%]$40,500  

Adjusted balance of Allowance account  $71,100

Net Realizable value of Accounts receivables[475000 - 71100]$403,900

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