Allowance for Bad Debts Essay
Financial officers should recognize revenue when it is realized or earned. Selling of goods on credit basis results in sales and the creation of account receivables. Early payment of the debt leads to discounts that have to be factored in the amount of revenue received. Moreover, some of the account receivables may have problems paying up the money owed. Therefore, such a situation results in doubtful debts that reduce the overall amount of money collected. It is essential to evaluate the effects of doubtful debts on SIA.
Adjustment
The probability of bad debt determines the amount of expense that would be charged on the revenues. A bad debt expense is a cost that should be charged in the statement of financial performance. Therefore, an officer has to debit the income statement and credit the account receivable account. The move does not only increase expenses but also reduces the amount of current assets in a company. The measure reduces the revenues generated by a business in any fiscal year.
The balance sheet estimates the amount of bad debt as a percentage of sales. This method may be accurate as the business may use historical data to establish such a rate. An increase in the amount of account receivables may also imply that SIA may incur additional expenses. Thus, the management should make sure the right amount of account receivables is captured in the statement of financial position.
Impact
There is the need for the management to evaluate the accuracy of the financial statements. It is evident that several “guaranteed” MLF had been booked without making concessions. The case shows that the amount of the MLF collected is still in doubt. In such a scenario, the business has to evaluate the right amount of doubtful debt. Therefore, it may require the company to create substantial provisions for bad debts. Additionally, creative accounting may imply manipulation of the various books of accounts.
The management should also note that the amounts of account receivable might not be correct. Understating the account receivables has a direct impact on the current and quick ratios, which measure the liquidity of any business. Thus, a higher amount of bad debts implies that the organization will have to understate its license fees revenues. As a result, the profits will be understated, and the retained earnings would decrease correspondingly.
The original income statement shows revenue of 354.8 in 2015, 303.6 in 2016, and 299.8 in 2017. However, the reinstatement of these amounts resulted in their decrease. The revenues changed to 279.6 in 2015, 254.7 in 2016, and 295.6 in 2017 respectively. Moreover, an adjustment of the allowance for doubtful debt is likely to decrease the reinstated amounts further.
The case shows that a business should reassess the credit rating of the customers as it will not reduce the bad debts but also decrease the likelihood of the existing customers defaulting on their accounts. Additionally, there is the need for the management to come up with the right rate for the bad and doubtful debts. A wrong amount will affect both the income statement and the balance sheet. The success of SIA is dependent on the collection of debts.
Therefore, it is essential for the management to make sure there are better terms of business to the customers since it will enable them to repay their debts faster. Finally, the arrangement with the financial institution is likely to decrease the likelihood of bad debts.
