Exercise 7-1 Comparison of the Direct Write-Off and Allowance Methods of Accounting for Bad Debts

In its first year of business, Rideaway Bikes has net income of $145,000, exclusive of any adjust- ment for bad debts expense. The president of the company has asked you to calculate net income under each of two alternatives of accounting for bad debts: the direct write-off method and the allowance method. The president would like to use the method that will result in the higher net income. So far, no adjustments have been made to write off uncollectible accounts or to estimate bad debts. The relevant data are as follows:

Write-offs of uncollectible accounts during  the year                                                 $10,500

Net credit sales                                                                                                           $650,000

Estimated percentage of net credit sales that will be uncollectible                                      2%

Required

Compute net income under each of the two alternatives. Does Rideaway have a choice as to which method to use? If so, should it base its choice on which method will result in the higher net income? (Ignore income taxes.) Explain.