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Issue I: Allowance for doubtful accounts
The sale of goods and services, in this case the distribution of food products, on credit gives rise to short-term accounts receivable and notes receivable. Selling on credit always results in a credit loss because some customers cannot or do not pay their debts. An allowance for doubtful accounts is provided to account for this expected loss resulting from bad debts. Various methods may be used in calculating the allowance for doubtful accounts. Chan and Baaz have the choice to follow specific identification of problem accounts or the percentage of sales method; both methods are permitted by GAAP.
Establishing an allowance requires vigilance and careful estimations by management based on their opinions of the percentage of credit sales they don’t expect to recover. If management has a pessimistic outlook, the forecast for doubtful accounts is likely to be more than the actual loss from bad debt. In contrast, if management has an optimistic outlook, the forecast for doubtful accounts is likely to be less than the actual loss from bad debt. Events that haven’t yet occurred and that cannot be predicted also affect the difference in forecasts from actual amounts, for example the recession in this case. Accounting information is biased if the measurements result in consistent overstatements or understatements of the items being measured. Chan and Baaz must make sure forecasts for doubtful accounts are not consistently materially more or less than the actual loss. They should review from time to time their estimates and actual results.
The CICA Handbook identifies several factors that companies must consider when appraising each individual accou ...