Answer the following:

A. What are two methods of recording accounts receivable transactions when a cash
discount situation is involved? Which is more theoretically correct? Which is used in
practice more of the time? Why? (100 words)

The two methods of recording accounts receivable transactions when a cash

discount situation is involved are gross method and net method. The net method of
recording is considered more theoretically correct because it values the receivables at its
net realizable value. At the same time, recording the sales at net provides a better
assessment of the revenue recognized. If the buyer forfeits the sales discount, that is the
only time that the company reflects this amount as income. The common and widely
used method is the gross method. This method is simpler to apply and its use does not
have any generally substantial effect in the presentation of financial statements.

B. What is the theoretical justification of the allowance method as contrasted with the direct
writeoff method of accounting for bad debts? (100 words)

The theoretical justification of the allowance method is dual: (1) since revenue is
considered to be recognized at the point of sale on the expectation that the total
receivables are valid liquid assets, income periodically will be overstated to the level
when the receivables eventually become uncollectible. The matching principle requires
the revenue and expense to involve the need of gross sales in the income statement be
partially offset by a charge to bad debt expense based on the estimation of the accounts
receivables arising from gross sales that will be unconvertible to cash, and (2) accounts
receivable in the balance sheet portion should be stated at their net realizable value. The
allowance method does this by deducting from gross receivables the allowance for
doubtful accounts.