The following is an excerpt from a conversation between Pam Cahill, the president and owner of Mullion Wholesale Co., and Eric Hogg, Mullion controller. The conversation took place on January 3, 2006, shortly after Eric began preparing the financial statements for the year ending December 31, 2005.
Eric: Pam, I've completed my analysis of the collectibility of our accounts receivable.
My staff and I estimate that the allowance for doubtful accounts should be somewhere between $60,000 and $90,000. Right now, the balance of the allowance account is $18,000.
Pam: Oh, no! We are already below the estimated earnings projection I gave the bank last year. We used that as a basis for obtaining a $300,000 loan. They're going to be upset! Is there any way we can increase the allowance without the adjustment increasing expenses?
Eric: I'm afraid not. The allowance can only be increased by debiting the uncollectible accounts expense account.
Pam: Well, I guess we're stuck. The bank will just have to live with it. But let's increase the allowance by only $42,000. That gets us into our range of estimates with the minimum expense increase.
Eric: Pam, there is one more thing we need to discuss.
Pam: What now?
Eric: Ross, my staff accountant, noticed that you haven't made any payments on your receivable for over a year. Also, it has increased from $20,000 last year to $70,000. Ross thinks we ought to reclassify it as a noncurrent asset and report it as an "other receivable."
Pam: What's the problem? Didn't we just include it in accounts receivable last year?
Eric: Yes, but last year it was immaterial.
Pam: Look, I'll make a $50,000 payment next week. So let's report it as we did last year.
If you were Eric, how would you address Pam's suggestions?