On December 31, 20XX, Selling Stuff Inc. reviews its account balances. The company uses the allowance method for recording its bad debts (percentage of receivables); historical data show that 4% of receivables become bad debt. The balance in the A/R account is $600,000, and the debit balance in the ADA account is $4,000.
Make the required AJE for December 31, 20XX (Year 1).
How much is required in the ADA account to start 20XX (Year 2)?
.
Since the ADA account has a debit balance of $4,000, that means that, during Year 1, the company had $4,000 more bad debt than was expected—the bad debt expense was understated. To reach $24,000, Selling Stuff Inc. must add $28,000 to the ADA account. This amount will cover the prior year's understatement plus the amount of bad debt expected for the current year.