AIPB Mastering Adjusting Entries Practice Test 2025 - Free Adjusting Entries Practice Questions and Study Guide

When a company adjusts its allowance for bad debts to account for an increase from 1% to 3%, this reflects a higher estimate of uncollectible accounts based on historical data or anticipated customer behavior. The necessary adjustment results in recognizing an additional bad debt expense, which is recorded on the income statement.

Increasing the estimate of bad debts from 1% to 3% implies that the company expects a greater portion of its accounts receivable will not be collected. This increase in anticipated expenses decreases net income, which in turn affects the company's equity since net income contributes to retained earnings. As expenses rise, they directly reflect in the income statement, indicating that the company anticipates losing more income due to higher uncollectible accounts.

Thus, recognizing an increase in bad debt expenses clearly demonstrates how the financial position changes; it highlights the immediate impact on profitability and equity, solidifying why increasing expenses is the correct response to the scenario.