Question

You are the chief accountant for ZM Corp., which is located in Illinois. In November 2017, that state had the second highest unemployment rate in the Midwest: 4.9% (down from 6.1% in January 2015).¹ For the past few years, you have noticed that the company’s bad debt rate has been about 7% of year-end accounts receivable. That rate of bad debts has severely affected the company’s profitability…especially since management has steadily been lowering the standards for granting credit to customers.

Your salary structure (as well as that of other corporate managers) allows for a bonus when net income is equal to or greater than a specific percentage of net sales. Unfortunately, that profit metric has not been reached in four years. However, the CEO and CFO (who is retiring after the first quarter of 2018) realized that a change in the bad debts percentage would allow them and you to obtain bonuses in 2017. If bad debts were computed at 2% of year-end A/R rather than 7%, everyone would receive a reasonable (but not extreme) bonus for 2017. The CEO justifies the use of that rate by concluding that, since unemployment in Illinois has been decreasing over the past few years, so will bad debts.

a.   Is a change in a bad debts estimate permissible under generally accepted accounting principles? If yes, explain how such a change is effected. If no, explain why such a change would not be allowed. (1 pt.)

b.   Would making such a change in the bad debts estimate violate any basic accounting concepts? Explain your yes or no answer. (2 pts.)

c.   Provide at least two alternatives to help improve the company’s profit performance. (1/2 pt. for each, up to 1 pt.)

d.   You have a new baby at home as of September 2017. The bonus would help with the added expenses. Additionally, you are up for promotion to CFO next year upon the retirement of the current CFO; allowing the current CEO and CFO to receive their bonuses would certainly bring positive recommendations for that new position.

      1.   Is reducing the bad debts estimate illegal? Explain. (1/2 pt.)

      2.   Is reducing the bad debts estimate unethical, given the CEO’s justification? Explain. (1/2 pt.)

e.   Assume that the CEO and CFO are very adamant that the bad debts percentage be reduced in 2017 to 2% of year-end receivables. The 5% difference is not material to the financial statements. You believe that you will be terminated if you don’t make this adjustment. What should you consider in making your decision? (2 pts.)

¹http://www.ncsl.org/research/labor-and-employment/state-unemployment-update.aspx;

http://www.ncsl.org/documents/employ/STATE-UI-RATES-2015.pdf

Answer 1