Question

Morrison Supply sells pressured air devices that assist patients with breathing disorders during sleep. These devices are delivered to patients immediately upon completion of a diagnostics exam, and are subsequently billed to insurance companies. Insurance companies sometime refuse to pay and/or only agree to a reduced price. Patients are then responsible for any amount denied by the insurance company, but are often unable or unwilling to pay. Because clinical standards of cleanliness must be maintained, Morrison is unable to accept returns for resale to others. Morrison is reluctant to litigate to collect unpaid amounts. As a result, Morrison experiences a high rate of uncollectible accounts, and prepares a monthly adjusting entry for uncollectibles.

January was Morrison's first month of operations. Monthly sales, write-offs, and ending receivables balances for the first quarter of 20X7 follow:

MONTH SALES ACTUAL WRITE-OFFS ENDING GROSS RECEIVABLES ENDING ALLOWANCE BALANCE

January $630,000 $ 80,000 $400,000 $70,000

February $480,000 $ 90,000 $650,000 $150,000

March $590,000 $125,000 $900,000 $210,000

(a) Prepare monthly journal entries to summarize sales on account, the recording of the provision for uncollectibles, and the actual write-offs, and collections.

(b) Morrison's CFO attended a trade group conference, and learned providers of this service in other cities have begun offering a 10% cash discount if the patient will pay the full amount themselves. The patient then deals directly with their insurance carrier for reimbursement. What are your thoughts on this policy?

(c) Morrison Supply is contemplating issuing shares of stock to a group of outside investors. The CEO has requested the CFO to adjust the allowance balances to reflect a lower rate of uncollectibles. What might be the motivation behind this request, and how should the CFO respond?

Answer 1

	Sales	Collection	write off
January	630000	80,000	80000
February	480,000	400000	90000
March	590000	155,000	125000
Accounts Receivable	January	February	March
Opening Balance		400,000	650000
Sales	630000	480,000	590000
Write off	-80000	-90000	-125000
Allowance	-70000	-80000	-60000
Collection	80,000	60,000	155,000
Closing balance	400,000	650,000	900,000

Date	Particulars	Debit $	Credit $
Jan 20x7	Sales	630,000
	Accounts Receivable		630,000
Jan 20x7	Bad Debts	150,000
	Allowance for Doubtful debts		150,000
Jan 20x7	Allowance for Doubtful debts	80,000
	Accounts Receivable		80,000
Jan 20x7	Cash	80,000
	Accounts Receivable		80,000
Feb 20x7	Sales	480,000
	Accounts Receivable		480,000
Feb 20x7	Bad Debts	170,000
	Allowance for Doubtful debts		170,000
Feb 20x7	Allowance for Doubtful debts	90,000
	Accounts Receivable		90,000
Feb 20x7	Cash	60,000
	Accounts Receivable		60,000
Mar 20x7	Sales	590,000
	Accounts Receivable		590,000
Mar 20x7	Bad Debts	185,000
	Allowance for Doubtful debts		185,000
Mar 20x7	Allowance for Doubtful debts	125,000
	Accounts Receivable		125,000
Mar 20x7	Cash	155,000
	Accounts Receivable		155,000

b) The policy is better compared to the current policy since actual write off percentage on sales  is 17% for the quarter, offering the 10% discount and getting the full amount is thus beneficial financially as it will increase the cash inflow and thus profits.

Also there would be no need to account for allowance for debt and bad debts expenses. Also there would be no requirement to follow up from the insurance companies for the payment.

This decision would be thus beneficially both from financial and operational perspective.

c) Reducing the allowance means increasing the debtor balance by writing back expenses and increasing profits. Reduction of allowance will make balance sheet look more attractive for the investor.

The CFO should respond by saying that provision for doubtful debts can be reworked and be provided based on actual bad debts percentage of accounts receivable.

The financial statement should reflect true and fair view to enable investors make a knowledgable decisions and the management estimates and provison should be fairly estimated.