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.

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 taxeffects.

Transcribed Image Text:

Operating Accounts Average Accounts Age Group Revenue Receivable Age Written Off Two years ago 2,300.000 80,000 13 days $10,000 Last year Current year 3,100,000 100,000 11 days 15,000 3,00,0000 350,0027 days