Question

Estimating bad debts can be done by the percentage of sales method and the aging of accounts receivable method. each method has its drawbacks and advantages. If the company, you were reviewing used the percentage of sales method and you noted that the allowance shown on the balance sheet was growing disproportionately to the accounts receivable give possible reasons for the disproportionate growth and suggest a means to adjust this situation if necessary. See example below.

Year                                    Accounts Receivable Allowance     Percent of A/R

2014                                         4,500,000                                            450,000     10.0%

2015                                         5,200,000                                            600,000    11.5%

2016 7,500,000 950,000    12.7%

Answer 1

Answer)

Here,we can see there is increase in sales along with estimating bad debts and hence,the sales is the major reason for increasing in baddebts.Here are some possible reasons for disappropriate growth in bad debts:

1)The organisation in profit hunger may sell the goods on credit basis without proper enquiry on the debtor.

2)The organisation may set aggressive sale targets to the employees which force them to sell the goods of the organisation aggressively.

3)There may be percentage of commission offered to the sale representative on amount of sale and they may sell the goods for more commission.

Measures to adjust current situation:

1)Send the invoices promptly and start chasing the debtors as soon as the credit period allowed completed.

2)Formulate a diplomatic way asking for payment immediately to the customers with whom you want to continue your relationship.

3)If the customers is too small to waste any resources for sale of collection of overdue then keep his orders on hold until he clear the over due.

4) Appointment of Lawyer and sending him the legal notice can work immediately in many cases.

5) Finally formulate a new set of rules on credit sales and explain it clearly to the sales representative and debtors and also provide some rewards like discounts for early payments