Question

(Bad-Debt Reporting) Marvin Company is a subsidiary of Hughes Corp. The controller believes that the yearly allowance for doubtful accounts for Marvin should be 8% of gross accounts receivable. Given the recession and the high interest rate environment, the president, nervous that the parent company might expect the subsidiary to sustain its 10% growth rate, suggests that the controller increase the allowance for doubtful accounts to 9%. The president thinks that the lower net income, which reflects a 6% growth rate, will be a more sustainable rate for Marvin Company.

Instructions

(a) In a recessionary environment with tight credit and high interest rates:

(1) Identify steps Marvin Company might consider to improve the accounts receivable situation.

(2) Then evaluate each step identified in terms of the risks and costs involved.

(b) Should the controller be concerned with Marvin Company’s growth rate in estimating the allowance? Explain your answer.

(c) Does the president’s request pose an ethical dilemma for the controller? Give your reasons.

Short answer

Improving credit policies will generally lead to loss of customers and increase some of the costs. The growth rate is not considered in the calculation of the estimated allowance.

Step-by-step solution

Definition of Ethical Dilemma

The situation under which the individual is not able to decide which course of action should be followed among various alternatives is known as an ethical dilemma.

Steps to improve the situation of accounts receivables

Serial Number	Steps to Improve Receivables	Risk and Cost involved
1	Restrictive credit policies or deep investigation before granting credit.	Such a policy will reduce the business entity’s sales and increase the cost of evaluating credit ratings.
2	The collection policy must be more rigorous.	Such policy might affect future sales because it will offend the current customers.
3	Charging interest on the customers not paying on time	This method will reduce sales and increase administrative expenses.

Growth rate in estimating allowance

The growth rate does not affect the allowance of the business entity. Therefore, it must not be considered while the determination of the allowance. While estimating allowances, the business entity must consider the write-off made in previous years and other economic factors that will affect the company’s industry.

Conflict in the interest

The controller wishes to present fair and complete information to the parent company, While the president wishes to misrepresent and manipulate the financial information to avoid the demands of the parent company. Such differences will lead to a conflict of interest, creating an ethical dilemma. The controller must identify different ways to resolve such a dilemma.