Cypress Company is a subsidiary of Peppermint Corp. The controller of Cypress be

Question

Cypress Company is a subsidiary of Peppermint Corp. The controller of Cypress believes that the yearly allowance for doubtful accounts for Cypress should be 2% of net credit sales. The president of Cypress, 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 3% yearly. The president thinks that the resulting lower net income, which reflects a 6% growth rate, will be a more sustainable rate for Cypress Company.

The main discussion points are:

1. Should the controller be concerned with Cypress Company's growth rate in estimating the allowance? Explain your answer

2. Does the president's request pose an ethical dilemma for the controller? Give your reasons.

3. How can accounting for bad debts potentially be used for earnings management? Give your reasons

Explanation / Answer

1) The Controller should not be concerned with growth rate in estimating the allowance. Bad accounts management should be done independent of growth. Cypress should not compromise on customer quality in order to chase growth.

2) Yes the president's request pose an ethical dilemma for the controller. In order to maintain company growth, president is asking 1% extra allowance for bad accounts. This gives the company flexibility to increase its business to non quality customers and compromise on corporate ethics.

3) By increasing Bad accounts, company tend to be complacent and tend to lend to people beyond there limits. This can help increase your revenues but long term impacts can be disastorous for the company. So company can lend to any customer who ask for credit and in return increase small proportion of Bad accounts.

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