Question

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 places (ex: 0.02345 = 2.35%).

	2013	2014	2015	2016
% allowance	Answer %	Answer %	Answer %	Answer %

c. Assume that we want to reformulate the balance sheet and income statement to reflect a constant percentage of allowance to gross accounts receivables for each year. Compute the four-year average and then reformulate the balance sheet and income statements for each of the four years. Follow the process shown in Analyst Adjustments 5.2 and assume a tax rate of 35%.

Four- year average of percentage of allowance to gross accounts receivables.

Round answer to two decimal places (ex: 0.02345 = 2.35%)

Answer

%

Reformulate the balance sheet and income statements.

Round answers to one decimal place.

Use negative signs with answers to indicate the adjustment decreases an account.

		2013	2014	2015	2016
Adjusted allowance for doubtful accts.		$Answer	$Answer	$Answer	$Answer
Balance Sheets Adjustments
Allowance for doubtful accounts		Answer	Answer	Answer	Answer
Accounts receivable, net		Answer	Answer	Answer	Answer
Deferred tax liabilities		Answer	Answer	Answer	Answer
Retained Earnings		Answer	Answer	Answer	Answer
Income Statements Adjustments
Bad debts expense		Answer	Answer	Answer	Answer
Income tax expense at 35%		Answer	Answer	Answer	Answer
Net Income		Answer	Answer	Answer	Answer

Answer 1

a. Accounts receivable gross for each year
$ millions	2013	2014	2015	2016
Accounts receivable, gross	$7,836	$7,284	$7,156	$7,724
Accounts receivable, gross = Account receivable, net + Allowance for doubtful accounts
Accounts receivable, net	$7,666	$7,105	$6,965	$7,499
Allowance for doubtful accounts	$170	$179	$191	$225
Accounts receivable, gross	$7,836	$7,284	$7,156	$7,724
b. Percentage of allowance to gross accounts receivable for each year
	2013	2014	2015	2016
% allowance	2.17%	2.46%	2.67%	2.91%
% allowance = Allowance for doubtful accounts/ accounts receivable, gross
c. Four year average % of allowance to gross accounts receivables
Average % = Percentage for four years/4
=(2.17+2.46+2.67+2.91)/4
=10.21/4
=2.55
Reformulate the balance sheet and income statement
	2013	2014	2015	2016
Adjusted allowance for doubtful accounts	$199.8	$185.7	$182.5	$197.0
Balance sheet adjustments
Allowance for doubtful accounts	29.8	6.7	-8.5	-28.0
Accounts receivable, net	-29.8	-6.7	8.5	28.0
Deferred Tax liability	-10.4	-2.3	2.9	9.8
Retained Earnings	-19.4	-4.4	5.6	18.2
Income statement Adjustments
Bad Debts Expenses	29.8	6.7	-8.5	-28
Income tax expenses @ 35%	-10.4	-2.3	2.9	9.8
Net Income	-19.4	-4.4	5.6	18.2
Increase in expense will reduce the income and thus result in reduced income tax expenses
Vice versa decrease in expenses will increase the income and income tax expenses.
Adjusted allowance for doubtful accounts = Accounts receivable, gross x 2.55%
Balance sheet adjustments
Allowance for doubtful accounts = Adjusted allowance for doubtful accounts - allowance for doubtful accounts
	2013	2014	2015	2016
Adjusted allowance for doubtful accounts	$199.8	$185.7	$182.5	$197.0
Allowance for doubtful accounts	$170	$179	$191	$225
Difference	$29.8	$6.7	($8.5)	($28.0)