Question

Assignment Questions:

Assume that you are preparing Galore Ltd’s yearly allowance for doubtful debts based on 2% of net credit sales, which will potentially result in 10% growth rate. The managing director, Ms Sharon Shady (Sharon), suggested you to increase the allowance for doubtful debts to 4% in order to achieve a 5% growth rate. Sharon said to you that: “we do not want our shareholders to expect our company to sustain a 10% growth every year rather, a 5% growth rate is more sustainable for our company.”

You are required to conduct research (i. e. reviewing relevant accounting standards and policies as well as academic and professional journals) and write a business report by addressing the below questions.

Please note:

The total marks of this assignment are 50 (i. e. 10 marks for Part A, 20 marks for Part B, 10 marks for organization and clarity, and 10 marks for grammar, mechanics, formatting and referencing), then your marks will be converted to 10% towards your overall assessment. Refer to the detailed marking rubric on page 3.

      

1

Part A

1). What are the relevant factors that should be considered when estimating yearly allowance for doubtful debts?
2). How does the allowance for doubtful debts potentially impact Galore Ltd’s financial reports?

Part B

1). a. Is it ethical to follow the managing director, Sharon, to estimate the allowance for doubtful debts based on a predetermined 5% growth rate?

b. Will you follow Sharon’s suggestion?
2). How does your decision about whether to follow Sharon’s suggestion influence various stakeholders? You are required to provide detailed explanations.

Answer 1

Hi there! As there are multiple questions in it, each with sub-parts, I will answer the first four parts only.

Part A. 1.)

Estimation of doubtful debts for making a provision in the financial statements is a tricky process, where the company has to evaluate the past trends and future estimations, taking into consideration the status and financial health of the debtors.

The management should provide for a provision for doubtful debts, based on the below factors and after carefully considering each aspect. The decision which they arrive at should be rational and based on facts, rather than on pre-decided targets.

1. What is the past trend of debtors going bad?
2. What is the future expectations of the debtors going bad, if there are some new debtors in the list?
3. Is there any adverse change in the financial health of some debtors?
4. Is there any economic slowdown, which may cause more than usual bad debts?

Considering all the above facts and management estimate, the provision for doubtful debts should be provided for in the books.

2.) As the allowance for doubtful debts is an expense, it increases the expense of the company and consequently, lowers the profit of the company. Arriving at allowance for doubtful debts should be a scientific process and not based on the personal choice of someone.

If the allowance is more, the profits will be lower and if the allowance is less, the profits will be higher.

Part B. 1.)

a. It is not ethical to estimate the allowance for doubtful debts based on predetermined 5% growth rate, as the decision for allowance should be based on scientific and rational evaluation by the management, instead of some predetermined targets.

Estimation of the allowance for doubtful debts based on predetermined 5% growth rate leads to manipulation of the profits of the company and may not present true and fair picture of the financials of the company.

b. We should not follow the suggestion of Sharon as the determination of allowance for doubtful debts should be based on factors as mentioned in Part A 1.) and not based on some predetermined targets.