Question

1. How are bad debts accounted for under the direct write-off method? What are the disadvantages of this method?

2. Define the six principles of control activities and give an example of each. An example may include how to prevent fraud or a type of fraud that could occur if these activities are not in place.

Answer 1

1. Under direct write off method no allowance account has been created. Any irrecoverable amount of trade receivables deducted to the expenses after determining non collectible from the customers.

Disadvantages of direct write off method :

A. It violates matching principle : When dues get irrecoverable from customers then it has been shown as bad debt expense. But credit sales may has been done in different accounting year. So, if credit sales made to a customer and bad debt arises from the same customer in different accounting year, then direct write off method violets matching principle. Because in matching principle expenses for different accounting year not been considered in current year.

B. Overstatement of assets: For a small business if a portion of trade receivables is not collectible from the time of sale, it still shows as a whole in the assets. Which actually overstating the value of trade receivables.

C. Inappropriate statement of profit: As per matching principle same year expenses deducted from same year revenues to calculate profit. But due to the use of direct write off method, during the time of sale the actual profit gets overstated ,where still there is a chance of irrecoverable debts and when bad debts deducted to expenses after determining uncollectible debts in upcoming accounting year, upcoming year profit gets under stated due to that.

2. Six principle of control activities with examples:

1. Establishment of responsibility : It creates distinct responsibility for every one. By which it can limit the access to some personnel. It specifically limits the authorization and approval of transactions according to the credentials. Cash fraud can be reduced by these.

2. Segregation of duties: Different jobs given to different personnel. Nobody is fully responsible for the whole work. It reduce duplication of work. Record keeping of assets should be separated from physical custody of the assets. It reduce the chance of physical assets fraud.

3. Documentation procedures :It makes the record keeping up-to date and accurate. Which can provide on demand report and documents without wasting time. It maintains the evidences of transactions .It reduced the chances of fraud.

4. Physical control : It creates reliability among the verification process . Physical stock fraud can be controlled or checked by it. It includes review, comparison, reconciliation of data. Periodic verification, discrepancy and exception should be reported to the management.

5. Independent internal verification: When internal verification is been done independently, it reduced the chances of favoritism and related issues.

6. Human resources control : It helps to manage human resources more effectively. Only employees with higher bonding will be allowed to handle cash. Rotation is necessary for assignment of duties. Mandatory vacation must be given periodically to the employees. Otherwise by extreme regularity commitment of fraud would be easy.