Question

As the accountant for SaveMart, the nation’s largest retail company, you have performed an extensive analysis, and you are convinced that bad debts will be 3% of credit sales this year. While this estimate is higher than last year’s estimate of 2%, you feel the increase is warranted because the company, in an effort to stimulate sales, significantly relaxed its credit policy in the current fiscal year. However, if the 3% estimate is used, SaveMart’s earnings will fall slightly below analysts’ earnings estimates, which some investors consider when valuing SaveMart shares. If the bad debt estimate is lowered to 2.5%, SaveMart will meet analysts’ earnings expectations, and you will receive a large bonus in the current period. Because bad debt estimates have historically been between 2% and 3%, you are quite certain that the auditors will accept any estimate in this range.

Question: What are your responsibilities?

Answer 1

The length of time an account is outstanding is important in estimating of its future collection because credit risk trends to increase with the age of account receivable. For example a company is more likely to collect an account that is 20 days old than once a 360 days overdue. For this reason company should choose more sophisticated method of estimating bad debts otherwise it will not show company true and fair value financial and it will impact on his future financial also.

It will not show the correct picture of accounts receivable also and aging of the outstanding. So we should give the clear picture to the auditor and management.