Question

The president of Remo Ltd. (Remo) wants to use hidden reserves to “save” income for a year when the company isn’t performing very well. To accomplish this objective, the president instructed the accounting department to overestimate the bad debt expense each year. Instead of using the historical norm of 1.5 percent of credit sales, the president suggested using 1.75 percent of credit sales. Remo commenced this “policy” in 2014 and it has continued through 2018, a period in which Remo has been very successful. The following information about Remo is available:


The credit balance in Remo's allowance for uncollectible accounts on January 1, 2014 was $63,000.

Required:
a. Prepare a table that shows
i. Remo's bad debt expense from 2014 through 2018 using the 1.5 percent rate.
ii. Remo's bad debt expense from 2014 through 2018 using the 1.75 percent rate.
iii. The allowance for uncollectible accounts at the end of each year using each of the estimates.
iv. Net income for each year using each of the two estimates.
b. How could the president of Remo justify using the 1.75 percent rate for estimating bad debts?
c. In 2019, Remo's net income fell slightly and the president was concerned about a negative response from shareholders and creditors. He was especially concerned that Remo was planning to approach new equity investors to invest in Remo. Credit sales during 2019 were $5,191,000 and net income for the year, excluding the bad debt expense, was $441,410. At this point, the president "recognized" the error that had been made over the previous five years and decided it was time to correct it. The president instructed the accounting department to reduce the bal ance in the allowance account to the level that would have existed had Remo used 1.5 percent of credit sales as the basis of calculating the bad debt expense each year.
i. What journal entry would be prepared to reduce the balance in the allowance account to the desired level?
ii. What would the effect on net income be of making this journal entry?
d. Why are hidden reserves a serious problem that undermines the integrity and usefulness of accounting information?


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  • CreatedFebruary 26, 2015
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