Question

You are the accountant for London Imports and Exports. The company imports and exports food and candy items throughout the world. The company is finalizing its 3^rd quarter financial results. All adjustments have been made for the 3^rd quarter except the adjustment for Bad Debts Expense. The preliminary 3^rd quarter results along with the 1^st and 2^nd quarter results are shown below.

London Imports and Exports Quarterly Income Statements (amounts in thousands of U.S. dollars)
	Q3 (preliminary)	Q2 (as reported)	Q1 (as reported)
Net Sales	$135,800	$135,460	$130,100
Cost of Goods Sold	(58,400)	(58,250)	(55,990)
Gross Profit	$77,400	$77,210	$74,110
Selling, General, & Admin. Expenses	(56,560)	(53,975)	(53,690)
Bad Debts Expense	--------	(6,050)	(4,200)
Income Before Income Tax	20,840	17,185	16,220
Income Tax Expense	(5,620)	(5,155)	(5,020)
Net Income	$15,220	$12,030	$11,200

The CFO asked you to look at the Allowance for Doubtful Accounts and use the Aged Accounts Receivable to calculate the adjustment needed for bad debts expense for the 3^rd quarter. The CFO stated that he knows the customers are slower at paying this quarter but he wants the Allowance for Doubtful Accounts to not be increased; in fact he’s encouraging you to decrease it so it has an adjusted balance of $8,000. He wants you to play around with the estimated bad debt loss rates to get the number he wants for the adjusted balance of the Allowance account. You are confused, so you decide to analyze the Allowance for Doubtful Accounts, and you came up with the following summary of the T account below:

Allowance for Doubtful Accounts
	7900                   Jan. 1 Balance Forward
Q1 Write Offs                                      4110	4200                  Q1 Bad Debts Estimate
	7990                  March 31 Adjusted
Q2 Write Offs                                      4120	6050                  Q2 Bad Debts Estimate
	9920                  June 30 Adjusted
Q3 Write Offs                                      4030	--------
	5890                  September 30 Unadjusted

AGING OF ACCOUNTS RECEIVABLE SCHEDULE:

Number of Days Unpaid	0-30 Days	31-60 Days	Over 60 Days	Total
Total Accounts Receivable	$10,000	$35,000	$78,000	$123,000
Estimated Uncollectible %	1%	8%	12%

Answer the following questions:

1. What is the problem with the Controller asking you to "play around with the estimated bad debt loss until you get it to work"?

2. If you were to record the bad debts expense based on what you learned in accounting, what amount would you record and how did you calculate this?

3. If you were to record the bad debts expense based on what the controller wants, what amount would you record and how did you calculate this?

4. Is there any evidence of unethical behavior in this case? Thoroughly explain your answer. Be sure to mention how net income would be affected based on your answers to #2 and #3 and how this would affect stakeholders. State what you believe is the ethical course of action.

Answer 1

Answer-

1- Controller is asking to play around with the estimated bad debt loss to show healthier financial statement, as bad debts expenses increases , solvency or liquidity capacity of the business will be decreased. Company will be considered not capable to recover money from it's accounts receivables.

2- If I had to record the bad debts expenses based on what I have learned in accounting,I would have record it on using ageing method as given in the question. Like 1% of $10000 (0 to 30 days) i.e. $100 plus 8% of $35000 (30 to 60 days) i.e. $2800 plus 12% of $78000 (60 days above) $9360 so total bad debts expenses will be $12260.

3- If I have to record bad debts expenses as the controller wants then I would have to record it as $2110 ($8000-$5890) as mentioned in the question controller wants to keep the allowance for doubtful accounts balance as $8000. According to the allowance for doubtful account balance we have to figure out bad debts expenses amount which is$2110.

4-As per my opinion there is unethical behavior find in this case as the controller doesn't want to show actual status of it's accounts receivables which will lead to false image of it's financial statement. Net income will be effected as per the answer as given in 2 question and 3 question , As per 2 question bad debts expenses will be recorded $12260 and thus deducted from gross profit ($77400-$56560-$12260) Net income as per 2 question will be $8580. As per 3 question bad debts expenses will be$2110 and deducted from gross profit ($77400-$56560-$2110) $18730. Hence net income will be shown with exceeding value of $10150 ($18730-$8580). Thus net income as per books will be greater than actual net income,this will affect stakeholders as well because they consider company's financial position is strong,they invest more and rely on company but in actual it is totally opposite. Like banks, financial institutions give more financial assistance on the basis of this false financial statement and this can be results into legal issue in future if the situation continue like this.