Basic Note and Accounts Receivable Transactions

Part 1 On July 1, 2010, Wallace Company, a calendar-year company, sold special-order merchandise on credit and received in return an interest-bearing note receivable from the customer. Wallace Company will receive interest at the prevailing rate for a note of this type. Both the principal and interest are due in one lump sum on June 30, 2011. When should Wallace Company report interest revenue from the note receivable? Discuss the rationale for your answer.

Part 2 On December 31, 2010, Wallace Company had significant amounts of accounts receivable as a result of credit sales to its customers. Wallace uses the allowance method based on credit sales to estimate bad debts. Past experience indicates that 2% of credit sales normally will not be collected. This pattern is expected to continue.

(a) Discuss the rationale for using the allowance method based on credit sales to estimate bad debts. Contrast this method with the allowance method based on the balance in the trade receivables accounts.

(b) How should Wallace Company report the allowance for doubtful accounts on its balance sheet at December 31, 2010? Also, describe the alternatives, if any, for presentation of bad debt expense in Wallace Company’s 2010 income statement.

(AICPA adapted)