Historically, your company has calculated bad debts using an aging of accounts receivable.Near the end of the fiscal year, the company is in a cash crunch and needs to borrow money from the bank, using accounts receivable as collateral.The owner of the company knows that many of the accounts receivable are more than 90 days past due, resulting in net receivables equal to only 80% of total receivables.

• The owner asks you to change the method of estimating bad debts to a flat 3% of receivables. What should you do?

In the preparation of the financial statements, the accounting principle of "objectivity" plays a big role. What that means is that the numbers in the financial statements are supported by actual evidence, such as invoices, receipts, etc. However, there are cases where there is no hard evidence. This is one of those cases. We have no way of knowing who will pay their bills and who will not. In this case management has to make an estimate. While there is no objective evidence, management is expected to use reasonable assumptions to arrive at their estimate.

• Please add to the second paragraph.