Question

Explain how management can shift income from one period into another by its estimation of uncollectible accounts.

Answer 1

In the income statement the bad debts expense is recorded when there is an increase in the allowance for uncollectible accounts. When there is an overestimation of the allowance account by the company, on the income statement net income would be understated, and on the balance sheet accounts receivable (i.e. the net of the allowance account) would be underestimated. Such a company in the future period would not require to add as much to its allowance account because it is overestimated already from that prior period (or, it may reverse the existing excess balance of allowance). Consequently the net income in future would be higher. On contrary, when the allowance account is underestimated by the company, then current net income would be overstated. However the net income in the future will be understated because the company need to add to the allowance account and must report more bad debts expense