Question

Tom Clark is a manager of a medium-size company. A few years ago, Clark persuaded the owner to base a part of the compensation on the net income the company earns each year. Each December he estimates year-end financial figures in anticipation of the bonus he will receive. If the bonus is not as high as he would like, he offers several recommendations to the accountant of the year-end adjustments. One of his favorite recommendations if for the controller to reduce the estimate of doubtful accounts.

1. What effect does lowering the estimate for doubtful accounts have on the income statement and balance sheet?
2. Do you believe Clark's recommendation to adjust the allowance for doubtful accounts is within his right as manager, or do you believe this action is an ethics violation? Justify you response.
3. What type of internal control(s) might be useful for this company in overseeing the manager's recommendations for accounting changes?

Answer 1

Tom Clark as manager recommended to reduce the estimate of doubtful accounts.

Doubtful accounts are amount that may be turned into bad debts or not be able to be received by the company in a particular period at a point in coming future.

Doubtful debts are not good for the company. This means they indicate loss for a company. The more is the amount of doubtful account, the more is the loss incurred by the company.

Lowering the estimate of doubtful accounts means showing in the books of accounting less bad debts than what actully occurred to the company. This way company can show that they are not bearing losses. It makes the figure of profit being increased.

If we talk about effect on income statement and balance sheet, accounts receivable shows the amount that is to be received in the balance sheet under asset. In the income statement, bad debt is calculated under company's income. Bad debt is an expense to the company, but company's manipulate that amount and reduce the resulting doubtful account. This also leads to show reduced loss to the company. In the income statement losses are reduced and hence it is reflected that company has made profits in the financial year.

Same is the case for balance sheet, the amount from income statement is carried to balance sheet and carrying same manipulations which directs that company had made huge profits but is not correct. Management thake these types of steps but these are not ethical.

Hence this showed the effect of manipulation on income statement and balance sheet.

No, doing these types of adjustments are not at all ethical. This may be misleading. The people who are willing to invest in this company, due to tom's idea of manipulation they can be misleaded. Hence this is not correct or ethical. As a manager he does not has the right to do manipulations. Because no any law states or gives right to the managers to do manipulations. Hence it is wrong. And on being caught they can also be punished.

Internal controls refers to rules and policies or procedures for running a business properly and also assures that the accounting principles and procedures used are correct.

If we talk about its type and how they are useful in overseeing manager's recommendations then, detective internal controls are the one that will look after and search if there is any error occurred by the activity of the manager that could be against the provisions and rules set. If any error is being seen further action could be taken. This way detective internal controls help detect the unlawful activity by the manager.

If we see the second type of internal control that is the corrective internal control, we can say that once any wrong activity is detected like we discussed in detective internal control, then correcting that error and making right provisions regarding that is under the corrective internal control. It helps in correcting the wrong activity done by the manager to protect from causing further loss.

Coming on the third type, preventive internal control, this controls take actions before errors are occurred. It is the preventive measures that can be taken to protect in advance. Like keeping an eye on working of accountants and managers, and judging the manager's activity and decisions. This could prevent in advance from indulging in any wrong deed.

So here we saw how the different internal controls can be used for overseeing the manager's activity and recommendations.