‘‘Just one,’’ John saidand it’s only an idea that you might want to pitch to the
ID: 2419482 • Letter: #
Question
‘‘Just one,’’ John saidand it’s only an idea that you might want to pitch to the management
team along with these other changes. We have used the percent of accounts receivable method to
calculate our Allowance for Bad Debt for several years. But we don’t have to use that method.’’
‘‘What do you mean?’’Elsa asked. ‘‘Isn’t the percent of accounts receivable method one of the
best ways to calculate the Allowance?’’
‘‘Technically, yes, it is. However, we recently hired a new credit manager who has improved
our collections and tightened our credit policy for new customers. Because of these improvements,
we might not have to use the percent of accounts receivable method. Instead, we could switch back
to the percent of sales method that we used previously. By switching from using 12 percent of
accounts receivable to 2 percent of credit sales, we would reduce our allowance for bad debts
and our bad debt expense. That would offset some of these negative changes we have just discussed.’’
‘‘What were credit sales for the year?’’ Simon asked.
‘‘About $1.25 million, and accounts receivable had an ending balance of $600,000 after we
wrote off $30,000 of uncollectible accounts. We wrote off almost $50,000 the year before, so our
collections really have improved. Honestly, I don’t think that we’d lose information quality by
switching methods. We don’t really have to use any specific method for estimating bad debt
expense. I think we could make a case for the more relaxed estimation method, and I think the
positive effect of the change on net income might help the management team accept some of these
other adjustments.’’ Elsa jumped in.
‘‘I don’t see any problem with that.’’ Simon frowned.
‘‘I’m not sure I like the idea of changing methods solely to offset the negative
effects of these other adjustments. But go ahead and calculate how switching methods would affect
our bad debt expense. We’ll meet again tomorrow morning, after I’ve talked with Jane and Doug
about how to handle these issues.’’
Estimate 1
Estimate 2
Current Sales Price
$750
$600
Historical Cost
$850
$850
Replacement Cost
$700
$500
Disposal Cost
$65
$70
Typical Markup
$200
$175
Units in Inventory
62
62
a. Based on the information provided in the take, calculate the write-down that would be necessary using the first set of assumptions.
b. Based on the information provided in the table claculate the write-down that would be necessary using the second set of assumptions.
c. Assuming that Frosty Co.'s management team decided to use the fist set of estimates, what correcting entries wouldd need to be made to write down inventory? (assume that Frosty Co. uses the direct write-off method)
d. What correcting entries would need to be made to write down inventory if the team decided to use the second set of estimates?
e. What would be the net effect of each of these inventory adjustments on net income? what would be the net effect on EPS?
Estimate 1
Estimate 2
Current Sales Price
$750
$600
Historical Cost
$850
$850
Replacement Cost
$700
$500
Disposal Cost
$65
$70
Typical Markup
$200
$175
Units in Inventory
62
62
Explanation / Answer
Ans 1 Details Amount Historical Cost 850 Replacement Cost 700 Max of NRV and Min of NRV-Profit NRV=750-65 685 NRV-Profit=685-200 485 No of Units 62 Total wite off to be provided 62*(850-485) 22630 Ans 2 Details Amount Historical Cost 850 Replacement Cost 500 Max of NRV and Min of NRV-Profit NRV=600-65 535 NRV-Profit=535-175 360 No of Units 62 Total wite off to be provided 62*(850-360) 30380 Ans 3 Inventory Write off Dr 22630 Inventory Cr 22630 Ans 4 Inventory Write off Dr 30380 Inventory Cr 30380 Ans 5 Estimate 1 Estimate 2 Net income -22630 -30380 EPS No of shares not provided No of shares not provided
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