Exploring Bad Debt Estimation Methods in Corporate Accounting

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2. Exploring Bad Debt Estimation Methods in Corporate Accounting: A Case Study of Dove Company Welcome to accountingassignmenthelp.com! Dive into our sample on Corporate Accounting where we delve into Revenue Recognition and Accounts Receivable. Explore how Dove Company estimates bad debt expenses and manages accounts receivable using both historical and aging methods. Understand the nuances of financial reporting for sound decision-making in corporate finance.

3. Revenue Recognition and Accounting for Account Receivables Dove Company's balance sheet for Dec. 31, 1999 included the following information: Accounts Receivable (net of allowance for doubtful accounts of $25,200) ......... $462,700 The company had credit sales of $870,000 during FY2000. Historically, the company's credit manager has estimated that 4% of credit sales will not be collected.

4. During FY2000, the company wrote off customer accounts with a face value of $30,000. At the end of the year, a newly hired analyst presented the credit manager with the following breakdown of outstanding accounts receivable and the probability of customer default Question 1

5. Required: If Dove Company continues to use its historical percentage-of-credit-sales approach, how much bad debt expense will it recognize for FY2000? What will it report as the ending balance for the book value of accounts receivable? If Dove Company applies the aging-of-accounts receivable method, using the credit analyst's estimates in the table above, how much bad debt expense will it recognize for FY2000? What will it report as the ending balance for the book value of accounts receivable? What do the differences between the numbers you computed for parts a. and b. above suggest about the accuracy of Dove Company's past accruals for bad debt? Has the company tended to over-estimate or under-estimate uncollectible credit sales? Briefly explain.

6. Answer Let's provide the detailed answer for Part a based on Dove Company's historical percentage-of-credit-sales approach: Part a: Historical Percentage-of-Credit-Sales Approach Calculation of Bad Debt Expense: Dove Company continues to use its historical percentage-of-credit-sales approach to estimate bad debt expense. Credit sales for FY2000 = $870,000 Historical estimate of uncollectible accounts = 4% of credit sales Therefore, the calculation for bad debt expense is: Bad Debt Expense=Credit  Sales×Estimated  Bad Debt Percentage\text{Bad Debt Expense} = \text{Credit Sales} \times \text{Estimated Bad Debt Percentage}Bad Debt Expense=Credit  Sales×Estimated  Bad Debt Percentage

7. 2. Ending Balance of Accounts Receivable: To determine the ending balance of accounts receivable under this method, we need additional information such as: Beginning balance of accounts receivable (net of allowance for doubtful accounts) Add credit sales during FY2000 Subtract collections (if provided) during FY2000 Subtract bad debt expense ($34,800) Without specific details on collections and adjustments, we cannot provide an exact numerical ending balance. However, the calculation typically involves subtracting the bad debt expense from the sum of the beginning balance and credit sales.

8. If Dove Company applies the aging-of-accounts receivable method, using the credit analyst's estimates in the table above, how much bad debt expense will it recognize for FY2000? What will it report as the ending balance for the book value of accounts receivable? Solution : Aging-of-Accounts Receivable Method Calculation of Bad Debt Expense: Dove Company applies the aging-of-accounts receivable method using the credit analyst's estimates provided in the table: Accounts Receivable Aging Analysis: 0-30 days: $400,000 with a probability of default of 0.5% 31-60 days: $90,000 with a probability of default of 1.0% 61-120 days: $40,000 with a probability of default of 10.0% More than 120 days: $20,000 with a probability of default of 70.0% Question 2

9. Calculation of bad debt expense: Therefore, Dove Company will recognize $20,900 as bad debt expense for FY2000 using the aging-of-accounts receivable method.

10. Ending Balance of Accounts Receivable: To determine the ending balance of accounts receivable under this method, we would sum up the outstanding balances in each aging category and adjust for any collections and write-offs during FY2000. Without specific details on collections and adjustments, we can't provide an exact numerical ending balance. However, the ending balance calculation typically involves: Adding the balances in each aging category (0-30 days, 31-60 days, 61-120 days, and more than 120 days). Subtracting the estimated bad debt expense ($20,900) from this total to arrive at the net book value of accounts receivable. This calculation would reflect the remaining amount of accounts receivable after accounting for expected uncollectible amounts based on the aging analysis.

11. Using the aging-of-accounts receivable method, Dove Company estimates $20,900 as the bad debt expense for FY2000. The exact ending balance of accounts receivable would depend on the specific collections and adjustments during the fiscal year, which are not provided in the question. However, this method provides a more detailed and accurate estimation of bad debt expenses compared to the historical percentage-of-credit-sales approach, as it considers the aging and probability of default of accounts receivable.

12. Question 3 c. What do the differences between the numbers you computed for parts a. and b. above suggest about the accuracy of Dove Company's past accruals for bad debt? Has the company tended to over-estimate or under-estimate uncollectible credit sales? Briefly explain.

13. Answer The differences between the calculations in parts a and b provide insights into Dove Company's past accruals for bad debts and whether the company has tended to over-estimate or under-estimate uncollectible credit sales. Difference in Bad Debt Expense: Historical Percentage-of-Credit-Sales Approach (Part a): Estimated bad debt expense = $34,800 Aging-of-Accounts Receivable Method (Part b): Estimated bad debt expense = $20,900 The historical method results in a higher estimate of bad debt expense compared to the aging method.

14. Implications for Past Accruals: Accuracy of Past Accruals: The difference suggests that Dove Company's past accruals for bad debts have tended to over-estimate the actual amount that will eventually become uncollectible. Tendency to Over- or Under-Estimate: Specifically, Dove Company has tended to over-estimate uncollectible credit sales with its historical percentage-of-credit-sales approach. This approach applies a fixed percentage (4% of credit sales) across all credit transactions, regardless of the specific aging and probability of default of individual receivables.

15. Explanation: The historical method's higher estimate of bad debt expense ($34,800) compared to the aging method ($20,900) suggests that Dove Company has historically set aside more funds for bad debt provisions than may have been necessary. This overestimation indicates a cautious approach to managing credit risk but may not accurately reflect the actual risk profile of the company's accounts receivable. In conclusion, adopting a more nuanced approach like the aging-of-accounts receivable method could potentially provide Dove Company with a more accurate estimation of bad debts. This method considers the specific aging and associated probabilities of default of accounts receivable, leading to a more precise reflection of the expected losses due to uncollectible accounts.

16. Dove Company's use of the historical percentage-of-credit-sales approach estimates a bad debt expense of $34,800 for FY2000, assuming 4% of credit sales are uncollectible. However, the method's simplicity may lead to overestimation without considering specific aging and default probabilities of accounts receivable. This approach highlights the need for more nuanced methods, like the aging-of-accounts receivable approach, which can provide a more accurate reflection of potential bad debts. Moving forward, Dove Company could benefit from adopting methods that align more closely with the actual aging and risk profile of its accounts receivable to enhance financial accuracy and decision-making. CONCLUSION