Answer:
The correct answer is B. (3,375) = NA + (3,375) NA − 3,375 = (3,375) NA.
Explanation:
The question asks for the effect of the adjusting entry on December 31, Year 1, that is, the creation of the 3% allowance for uncollectible debts.
Allowance for bad debts = 3% x $112,500 = $3,375
Its effect is as follows.
Assets: Since accounts receivable (an asset) is reduced, assets are reduced by $3,375.
Liabilities: No effect.
Equity: As Equity = Assets - Liabilities, the net effect is to reduce the equity by $3,375.
Revenue: No effect.
Expenses: Sales worth $3,375 is written off as an expense. Hence, total expenses increase by $3,375.
Net increase: As revenue remains unchanged while expenses increase by $3,375, the net increase is a negative of $3,375.
Cash flow: No effect, because there is no exchange of cash since the amount of $3,375 was never received by Loudoun Corporation.
These entries correspond to option B. which is thus the correct answer.
