Question

BTN 7-3 Anton Blair is the manager of a medium-size company. A few years ago, Blair persuaded the owner to base a part of his compensation on the net income the company earns each year. Each December he estimates year-end financial figures in anticipation of the bonus he will receive. If the bonus is not as high as he would like, he offers several recommendations to the accountant for year-end adjustments. One of his favorite recommendations is for the controller to reduce the estimate of doubtful accounts.

Required

1. What effect does lowering the estimate for doubtful accounts have on the income statement and balance sheet?

2. Do you believe Blair’s recommendation to adjust the allowance for doubtful accounts is within his rights as manager, or do you believe this action is an ethics violation? Justify your response.

3. What type of internal control(s) might be useful for this company in overseeing the manager’s recommendations for accounting changes?

Short answer

Answer

1. Lowering the estimate of doubtful accounts will increase the net income and assets of the business entity.

2. The Action of the manager is unethical.

3. Estimate of the allowances must be assessed quarterly by an independent individual.

Step-by-step solution

Step-By-Step SolutionStep 1: Definition of Bad Debts

The amount that will not collect from the receivables is considered a bad debt of the business entity. These bad debts are considered expenses of the business entity.

Effect of lowering the estimate for doubtful accounts

Reducing the estimate for doubtful accounts will reduce the expenses and increase the business entity’s profit. Due to a reduction in the allowance for doubtful accounts, the accounts receivables will increase, and therefore, the current assets of the business entity will also increase.

Action of the manager is ethical or unethical

The manager’s action is an ethical violation because the financial statement must report the true and fair value of the allowance. Estimates must be based on the previous experience of the business entity. The manager must not reduce the estimate of allowances only to generate higher income.

Internal control required

An independent individual must evaluate the balance in the allowance after each quarter. Such internal control will prevent the misstatement of the estimated allowance.