Question

Sky-High, Inc. pays company management bonuses at the end of each year if net income is equal to or greater than a specific percentage of net sales. However, in the past five years, that metric has not been reached. During these past five years, Sky-High has been lowering the requirements for granting credit to customers so that more sales can be generated. However, making those credit changes has caused the company’s uncollectible accounts percentage to rise substantially; for last year, it was 8.5% of the year’s net sales.

Before the past five years, Sky-High had been estimating uncollectible accounts at 3% of net sales. That rate had been effective in that no material adjustments needed to be made at any year-end. The CEO has asked you (the company accountant) to return to using that 3% percentage. His rationale is that the economy is strengthening and so uncollectible accounts should begin to decrease. If the 3% is used, all company management will receive a small bonus for this first time in five years.

1. A change in the estimate of uncollectible accounts is allowed under generally accepted accounting principles. How would such a change be accounted for?

Answer 1

Solution 1:

Yes, a change in estimate of uncollectible accounts is allowed under generally accepted accounting principles for estimating bad debts expense for the year if some new information is available that requires to change percentage of uncollectible to represent more accurate bad debt allowance.

Any change in accounting estimate is accounted as prospective adjustment. No retrospective adjustment is required for change in estimates as per generally accepted accounting principles.

However merely changing the percentage to manipulat the financials to get desired results is unethical as financial statements should provide accurate financial information to users.