Question

Canaday Ltd. has the following receivables balances ($M):

Gross accounts receivable	$ 176
Bad-debt reserve	(3)
Net accounts receivable	$ 173

Two years ago a customer was approved for an unusually large credit sale of $8M over the objections of the credit and collections department. Shortly after the sale, the customer's business began to deteriorate due to an unexpected recession. To date it has paid only $2M against the order despite the fact that it has consumed all of the material purchased. The collections department has worked diligently to collect the remaining $6M without success. The customer filed for bankruptcy this morning with essentially no assets to pay a large number of creditors. Evaluate the financial statement impact of the bankruptcy on Canaday. Assume Canaday's product cost is 40% of revenue and the bad-debt reserve of $3M will be fully reestablished. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000.

Immediate effect on the balance sheet
Gross accounts receivable	$   million
Bad-debt reserve	$   million
Net accounts receivable	$   million

The pretax loss due to the write off this year:
$__ million

Answer 1

Canaday Ltd.
Immediate effect on balance Sheet
Gross Account Receivable	$ 170 million
Bad Debts Reserve	$   0    million
Net Account Receivables	$ 170 million

Pretax Loss due to write off :

$ 6 million

Explanation:

Balance of Account receivable:

• As 6 Million can not be collected by collectiion department . This 6 million should be written off from account receivables.
• balance Account receivables = $ 176 million - 6 million = 170 million.

Balance of Bad Debt Reserve :

• As 3 million is already in bad Debt reserve , which will be utilised in write off . thus bad debts reserve balance will be zero after write off.

Pretax Loss :

• the balance 3 million of uncollected debt ( 6 million - 3 million ) will be written off as Bad debt expense.
• this bad debt expense written off will be shown in income statement as charge against profit , which will reduce pretax profit with $ 3 million .
• Bad debts reserve of $3 million needs to be fully reestablished , thus this amount will also increase bad debt expense with the same amount.
• Thus total pretax loss due to bad debts expense write off = $ 3 million + 3 million = 6 million.