Allowances: Following is information for Garrels Company's Allowance for doubtful accounts. Examine this information and answer the following questions.
Years Ended December 31,
($ in thousands) 2011 2010 2009
Allowance for doubtful accounts Balance beginning of year ? ? $1,324 Provision charged to expense ? 502 1,349 Write offs, less recoveries 1 622 ? Balance end of year 1,453 ? 1,302
1. Solve for the unknowns in the preceding schedule. Use T-accounts.
2. Make all entries related to the Allowance for doubtful accounts account for 2009 - 2011.
3. Make all entries for bad debts for 2009 - 20111 assuming that Garrels did not accrue for estimated bad debt losses but instead recorded bad debt expense once receivables were determined to be uncollectible. (This is called the direct write-off method.)
4. Why does GAAP require the allowance method over the direct write-off method?
5. Calculate the cumulative difference in reported pre-tax income under the allowance and direct writ-off methods over the 2009 - 2011 period.
6. Assume that it is the end of 2012 and Garrels management is trying to decide on the amount of the bad debt expense for 2012. Based on an aging of accounts receivable, the accounting department feels that a $400,000 provision is appropriate. However, the company just learned that a customer with an outstanding, accounts receivable of $300,000 may have to file for bankruptcy. The decision facing Garrels management is whether to increase the initial provision of $400,000 by $300,000, by some lesser amount, or by nothing at all. What is your recommendation?
7. Continuing the scenario from #6 above is the following additional information. Assume that you are a member of the company's compensation committee. Assume further that the company's chief financial officer (CFO) is solely responsible for deciding the amount of bad debt expense to record and that the CFO has a cash bonus plan that is a function of reported earnings before income taxes. Specifically, assume that the CFO receives an annual cash bonus of zero if earnings before income taxes are below $17 million and 10.0% of the amount by which earnings before income taxes exceeds $17 million and up to a maximum bonus of $1 million (that is, when net income reaches $27 million, no further bonus is earned). What adjustment to the initial $400,000 bad debt provision might the CFO make in each of the following scenarios? Assume that the following earnings before income taxes include the initial $400,000 provision for bad debts.
a. $11 million
b. $18.2 million
c. $38.25 million
d. $27.15 million
8. What other scenarios can you identify in which managers might use the provision for bad debts to accomplish some contract-related strategy?
9. Identify other items in the financial statements (besides the bad debt provision) that managers have the ability to "manage."