P5-5C Power Corporation engages in the manufacture and sale of equipment related
ID: 2588090 • Letter: P
Question
P5-5C Power Corporation engages in the manufacture and sale of equipment related to alternative sources of energy. During the past year, operating revenues remained relatively flat compared to the prior year but management notices a big increase in accounts receivable. The increase in receivables is largely due to the recent economic slowdown in the commodities market. Many of the company’s customers are having financial difficulty, lengthening the period of time it takes to collect on account. Below are year-end amounts. Age Group Operating Revenue Accounts Receivable Average Age Accounts Written Off Two years ago $2,300,000 $80,000 13 days $10,000 Last year 3,100,000 100,000 11 days 15,000 Current year 3,000,000 350,000 27 days 0 Peter, the CEO of Power, notices that accounts written off over the past three years have been minimal and therefore suggests that no allowance for uncollectible accounts be established in the current year. Any account proving uncollectible can be charged to next year’s financial statements (the direct write-off method). Required: 1. Do you agree with Peter’s reasoning? Explain. 2. Suppose that other companies in these industries have had similar increasing trends in accounts receivable aging. These companies also had very successful collections in the past but now estimate uncollectible accounts to be 30% because of the significant downturn in the industries. If Power uses the allowance method estimated at 30% of accounts receivable, what should be the balance of the allowance for uncollectible accounts at the end of the current year? 3. Based on your answer in Requirement 2, for what amount will total assets and expenses be misstated in the current year if Power uses the direct write-off method? Ignore tax effects.
Explanation / Answer
Age Operating rev AR Avg age Woff 2 yrs ago 2300000 80000 13 10000 last yr 3100000 100000 11 15000 C Y 3000000 350000 27 1. do not agree with peter statemnent because it is not prudent to charge one years bad debts in another years financials , this will lead of overstatement of profit of one year and understatement of profit of another year . Also it will lead to misstatement and uncorrect show of balance sheet . expesnes has to be booked in which income has benn booked - this rational would violate if peters statement would be applied 2 Provision for current year would be 30% of 350000 = 105000 , so first companyg have to create p[rovision of 105000 for current year then carry forward balacne has to be add in this ac . if we consider no opneing balance then balance in the uncolletible ac would be 105000 3 total assets would be overstated by 105000 in net and expenses at lower by 105000 .
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