Jasper Company uses the allowance method to account for bad debts. During 2016, the company recorded bad debt expense of $9,000 and wrote off as uncollectible accounts receivable totaling $5,000. These transactions caused a decrease in working capital (current assets minus current liabilities) of:

A) $7,000
B) $5,000
C) $9,000
D) $14,00

C) $9,000

Explanation:

There are two methods of accounting for bad debts: The Allowance Method in which a contra-asset account of credit balance is created and The Write-off Method under which the Receivables are decreased directly by the amount of bad debts. Jasper's policy is to use Allowance method to account for bad debts. Under this method, the management will credit a contra-asset against the bad debts, resulting in a reduction in current assets and hence net working capital, whenever it expects that a certain customer will default. In-case the customer actually defaults and fails to meet his obligations, the management will write-off the receivables and doing so would require a debit to Allowance for Doubtful Account and a credit to Accounts Receivable. This write-off entry has no impact on the Net Realisable Value (Accounts Receivable - Allowance for Doubtful Account), so it will not change the worth of current assets appearing on the face of balance sheet. This implies that the current assets or net working capital will be reduced by the amount of $9,000 and $5,000 will have no impact on the liquidity ratio.

C) $9,000

Explanation:

working capital = current assets - current liabilities

The allowance for uncollectible accounts is a contra asset account that reduces the value of accounts receivable (current asset). Since current assets decrease by $9,000, then working capital will also decrease by $9,000.

working capital = current assets - $9,000 - current liabilities

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