You will receive full points based on (1) providing a recommendation based on so

Question

You will receive full points based on (1) providing a recommendation based on sound accounting practices, (2) clarity and organization and (3) grammar and spelling.

Case Background

Your client, Clarkson Outdoors, Inc.is a wholesale merchandising business that sells outdoor furniture. The company’s average monthly sales revenue is $250,000 representing approximately 5,000 inventory items sold. Historically, it has a bad debt experience of approximately 1.5% of sales revenue. The company controller is seeking some guidance from you regarding the proper accounting for receivables, bad debts and the allowance for doubtful accounts. She has asked you the following questions:

•How should we set up the allowance account? We have considered basing it on some percentage of all receivables (should we age the receivables?) or basing it on the valuation of the past due and questionable accounts receivables.Shouldn’t we focus on the actual uncollectibles? Should we charge them against the allowance at the end of the period or should they be written off against gross sales? If an account is determined to be uncollectible in the current accounting period, shouldn’t we record bad debt expense then?

•We have expenditures when we make attempts to collect outstanding receivables –we pay for collection agencies and legal help in making collections. How should we record these amounts?We have considered (a) bad debt expense, (b) allowance for doubtful accounts, (c) legal expense or (d) administrative expenses.

•Sometimes we receive payments from customers for amounts that we have already partially orfully written off. If we recover these amounts, can we record this as OtherRevenue? What about just reducing current period bad debt expense?

Prepare a brief (no more than one-page) memo to the controller that addresses, in your own words the alternatives available for accounting for uncollectible receivables, including the issues she has raised.

Explanation / Answer

Ans 1. - As per the Accounting Standard and Framework for the Preparation and Presentation of Financial Statements it is advisable to account for the collectibles in an Aging Report Manner. Aging Report includes dues remaining for 0-30 days 31-60 days 61-90 days and 90 days and more. Using the above method or bifarcation a reminder call should be set up in order to attain whether the collectible is still receivable or not. Once the amount is confirmed as Not Collectible it should be removed from the receivable or collectibles account and be expensed out as Bad Debts. By this method we get to focus on actual collectibles at the end of year reporting period.

If theres an allowance created for the Bad Debts expenses in the books then such amounts should be accounted in that first as during the process of the creation of the allowances we have already charged the Profit and Loss Account.

However, Gross Sales cannot be reduced as this not a sales return, It will continue to be showed as sales and the corresponding effect should be given in the non operating cost for the company.

Ans. 2 - Expenditures incurred in lieu of the collectibes should be expensed out in the Profit and Loss Account separately as a Non Operating Cost to the company. Account Head specifically can be used is Legal Expenses as the company has to bare the legal charges to file the suit against the debtor and other connected charges. Also, the nature of expenses and the account match. Hence, it should be expensed off in the Legal Expenses Account.

As for the Bad Debts Expenses - This account includes the amount written off as non collectible. Hence, the expenses incurred to collect them should be accounted separately and not in the same account as the written off account as the nature of expenses are different.

As for the Allowance for Doubtful Debts - In this account there is a provision created for the possibility of the collectible to become bad debt. Hence the nature of account and the expenses are completely different from the once incurred to collect them.

As for the Administrative Expenses - In this account expenses in relation to the administrative work of the organisaion is collected. It is part of the Cost of Goods Sold. Hence, this expenses cannot be included in the COGS as for it vunerable nature.

Ans.3 - If the bad debts is recovered after been written off in the same year i.e. recovered in the year it is written off, we need to only reverse the adjustment and add it back to profits of the company.

However, If the bad debts are recovered in the subsequent year then we need to add it to the Other Income of the company as the company would need to pay taxes on the same since it was removed from the profit of the company in the previous year.

In case, only allowance is made for the debt we need to reverse the allowance and write it back as profits of the company.

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