6.On December 31, 2010, Priya Co. has accounts receivable of $400,000. It uses the direct write-off method of accounting for bad debts because this is what is required for determining its U.S. taxable net income. The opinion of management is that what is acceptable to the Internal Revenue System should be acceptable under generally accepted accounting procedures. However, its independent auditor disagrees with this impassioned argument and does not accept the direct write-off method of accounting for bad debts.
Present the reason(s) for the auditor’s objection to the direct write-off method, and indicate the method that must be used under GAAP. Indicate how Priya’s 2010 net income, current ratio, and quick ratio will be affected by following the auditor’s position.
7.A company has a significant debit or credit accumulation in the preadjustment balance of allowance for doubtful accounts over several periods.
Required:
(1) What would this indicate?
(2) How can users detect the source of this problem?
8.Preston Bank has $50 million of loans outstanding on December 31 of the current year, in which it recorded net income of $770,000. Preston did not provide for any uncollectible loans because all of its loans are collateralized by real estate. That is, if the loans were to default, Preston would obtain the title to the real estate for which the loans were made. However, during the audit of Preston’s financial statements, the auditing company determined that $5 million of the outstanding loans would probably be dishonored (uncollectible). Because during the last three years real estate values have deteriorated, they also investigated the real estate that backed these collateralized loans. The market value of that real estate is negligible.
Recalculate Preston’s loans receivable on December 31 and current net income to an amount that would be acceptable to the auditors.
9.Can a company use the direct write-off method rather than the allowance method to account for bad debts? Explain why or why not.