Question

2301 KEY ASSIGNMENT

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

1. Controller is asking to play around estimated bad debt loss rate in order to get the adjusted balance of bad debt of $8000 which is actually wrong. Bad debt expense cannot be calculated in such a manner. We have to prepare an aging schedule of debtors and accordingly calculate estimated bad debt exp. If such a procedure is not followed then it will not lead to true and fair view of position of accounts receivable as well as of bad debt expense.

2 . Following will be the amount of bad debts to be recorded :-

Statement showing aging of accounts receivable and balance of bad debt

Number of days unpaid	0-30 days	31-60 days	over 60 days	total
Total accounts receivable	$10000	$35000	$78000	$123000
Estimated uncollectible %	1%	8%	12%
Amount of uncollectible	$100	$2800	$9360	$12260

Balance of uncollectible should have been. $12260

Unadjusted balance right now. $5890

Bad debt expense to be recorded = $12260-$5890 = $6370

Thus, amount of bad debt expense should be $6370.

3. Controller wants the balance of uncollectible to be $8000

Unadjusted balance of uncollectible right now is $5890

Thus, bad debt expense to be recorded is$8000-$5890 = $2110.

4 . Yes, there has been ab evidence of unethical behaviour in what controller wants to do. If bad debt is calculated as per proper procedure which is mentioned in 2 . then net income will come out to be $15220-$6370 = $8850.

Whereas if bad debt is calculated as per the instructions of the controller which has been calculated in 3. then net income would come out to be $15220-$2110 = $13110.

We can see there is a difference of $13110-$8850 = $4260 in net income as per both the calculations .

It is wothwhile to be noted that if Net income will be calculated as per proper procedure then net income of firm for Q3 will show a decreasing trend as compared to net income of Q1 &2 which will decrease the confidence of stakeholders on the future earning capacity of the firm and will decrease the market price of common stock. However, if Net income is calculated as per the instructions of controller then net income of Q3 will show an increasing trend as it was showing earlier in Q1&2. which will enhance confidence of stakeholder on the earning capacity of the company and thus leslesd to increase the market price of the common stock. This clearly the behaviour shown by controller with regard to uncollectible amount is unethical and will affect the sentiments of stakeholders with respect to the warning capacity of the company.

Thus, the ethical course of action in the present situation will be to ignore the instructions of controller and calculate the balance of uncollectible as per 2. By properly preparing schedule of accounts receivable.