Question

In: Accounting

ily Company has historically reported a bad debt expense amount of between 1% and 4% of...

ily Company has historically reported a bad debt expense amount of between 1% and 4% of sales. The percentage for any given year is a function of both the business conditions for the year and whether recent experience suggests that the estimates in past years have been too high or too low. For example, if estimates in past years have been too high, a lower amount of bad debt expense is recognized in the current year. Lily Company's board of directors has met to review the preliminary financial statements for the just-completed fiscal year. Assume that the board will decide on a bad debt estimate of either 1% or 4% of sales, consider the following two scenarios: Scenario 1. The preliminary earnings number for the year is very high, far higher than expected. However, Lily's board is concerned about future years; there is some indication of unsettled business conditions ahead. Scenario 2. The preliminary earnings number for the year is quite low, lower than expected. The board has reason to be optimistic that Lily's operating performance will turn around next year. What estimate (1% or 4%) do you think Lily's board will choose in each of the two scenarios? Explain your choices. What risks are there to Lily Company if the bad debt estimate is chosen using only the type of information given here?

Solutions

Expert Solution

Scenario 1: In this scenario the bad debt estimate for this year should be 4%. This is because Lily Company, by recognizing a higher bad debt expense this year, will have the flexibility of recognizing lower bad debt expenses in future years when business conditions is expected to become unsettled, thus leading to a fall in earnings in future.

Scenario 2: In this scenario the bad debt estimate for this year should be 1%. This is because earnings number for this year is expected to be low but it is likely to increase in future years. Hence Lily Company will increase its bad debt estimate in future years when earnings will witness a revival in its growth.

Lily Company, by using only the information provided here to estimate its bad debt expenses, runs the risk of either overestimating or underestimating its bad debt expenses. The company has to select from only two percentages – i.e. 1% and 4% and this may not be realistic and accurate in all cases. Instead the company should use a statistical model and should increase the percentage as the age of its receivable increases.

ekkarill92 answered 1 year ago
Next > < Previous

Related Solutions

Vandross Company has recorded bad debt expense in the past at a rate of 1½% of...
Vandross Company has recorded bad debt expense in the past at a rate of 1½% of accounts receivable, based on an aging analysis. In 2017, Vandross decides to increase its estimate to 2%. If the new rate had been used in prior years, cumulative bad debt expense would have been $380,000 instead of $285,000. In 2017, bad debt expense will be $120,000 instead of $90,000. If Vandross’s tax rate is 30%, what amount should it report as the cumulative effect...
Reformulating Allowance for Doubtful Accounts and Bad Debt Expense Merck & Company reported the following from...
Reformulating Allowance for Doubtful Accounts and Bad Debt Expense Merck & Company reported the following from its 2016 financial statements. $ millions 2013 2014 2015 2016 Accounts receivable, net $7,185 $6,627 $6,485 $7,017 Allowance for doubtful accounts 153 160 172 201 a. Compute accounts receivable gross for each year. $ millions 2013 2014 2015 2016 Accounts receivable, gross $Answer 7,338 $Answer 6,787 $Answer 6,657 $Answer 7,218 b. Determine the percentage of allowance to gross account receivables for each year. Round...
Reformulating Allowance for Doubtful Accounts and Bad Debt Expense Merck & Company reported the following from...
Reformulating Allowance for Doubtful Accounts and Bad Debt Expense Merck & Company reported the following from its 2016 financial statements. $ millions 2013 2014 2015 2016 Accounts receivable, net $7,666 $7,105 $6,965 $7,499 Allowance for doubtful accounts 170 179 191 225 a. Compute accounts receivable gross for each year. $ millions 2013 2014 2015 2016 Accounts receivable, gross $Answer $Answer $Answer $Answer b. Determine the percentage of allowance to gross account receivables for each year. Round answers to two decimal...
Jake Company records bad debt expense using the net credit sales method and has estimated that...
Jake Company records bad debt expense using the net credit sales method and has estimated that 5.5% of its credit sales will prove to be uncollectible. During 2019, Jake Company reported net credit sales of $120,000 and collected $150,000 cash from its credit customers. The $150,000 includes a $6,000 recovery of an account receivable written off in the previous year. During 2019, Jake Company wrote-off as uncollectible accounts receivable of $4,000. Jake Company reported accounts receivable at January 1, 2019...
Jake Company records bad debt expense using the net credit sales method and has estimated that...
Jake Company records bad debt expense using the net credit sales method and has estimated that 5.5% of its credit sales will prove to be uncollectible. During 2019, Jake Company reported net credit sales of $120,000 and collected $150,000 cash from its credit customers. The $150,000 includes a $6,000 recovery of an account receivable written off in the previous year. During 2019, Jake Company wrote-off as uncollectible accounts receivable of $4,000. Jake Company reported accounts receivable at January 1, 2019...
Jake Company records bad debt expense using the net credit sales method and has estimated that...
Jake Company records bad debt expense using the net credit sales method and has estimated that 5.5% of its credit sales will prove to be uncollectible. During 2019, Jake Company reported net credit sales of $120,000 and collected $150,000 cash from its credit customers. The $150,000 includes a $6,000 recovery of an account receivable written off in the previous year. During 2019, Jake Company wrote-off as uncollectible accounts receivable of $4,000. Jake Company reported accounts receivable at January 1, 2019...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience with its customers. Cash sales have accounted for 20 percent of total sales, and payments for credit sales have been received as follows: 40 percent of credit sales in the month of the sale 35 percent of credit sales in the first subsequent month 20 percent of credit sales in the second subsequent month 5 percent of credit sales in the third subsequent month...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience with its customers. Cash sales have accounted for 20 percent of total sales, and payments for credit sales have been received as follows: 40 percent of credit sales in the month of the sale 35 percent of credit sales in the first subsequent month 20 percent of credit sales in the second subsequent month 5 percent of credit sales in the third subsequent month...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience...
Budgeted Cash Collections, Budgeted Cash Payments Historically, Ragman Company has had no significant bad debt experience with its customers. Cash sales have accounted for 20 percent of total sales, and payments for credit sales have been received as follows: 40 percent of credit sales in the month of the sale 35 percent of credit sales in the first subsequent month 20 percent of credit sales in the second subsequent month 5 percent of credit sales in the third subsequent month...
C 6-3 Bad Debt Expense LO 6.5AICPA Adapted When a company has a policy of making...
C 6-3 Bad Debt Expense LO 6.5AICPA Adapted When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible. As a result, a company must recognize bad debt expense. The two methods of recognizing bad debt expense are the (1) direct write-off method and (2) allowance method. Required: Describe fully both the direct write-off method and the allowance method of recognizing bad debt expense....
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT