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The Accounting Assignment is a Computer World a partnership firm having three partners i.e. Harry, Sue and Lee. They are in second year of business operation and exploring the business in terms of credit policy. In this report matters related to credit period or credit policy of company is define. Whether to collect money directly or on commission basis or by offering discount to customers were analysed in this report. Methods of bad debt recording or accounting were also defined in this report. Direct write off method and allowance method are discussed in this report. Implications and accounting treatment of these methods are explained. What is retrospective statement and whether it is required for change estimation of percentage used in allowance method are defined in this report.
There are three options available with market management plan of computer World. Option with which requires least cost or maximum receivables to organization that option will be selected. Following are three different options:
Option 1: Easy Money Mode
Easy money is a credit union which extends credit for company. In this case Computer world can opt this option and following are its related cost and receivables to company:
Commission = $ 350,000 x 4 / 100 = $ 14,000
Cost to Computer World = $ 14,000
Net Receivables = $ 350,000 - $ 14,000 = 336,000
Option 2: Self Collection of Credit
Under this option Computer World has to incur collection staff salary which amounts to $ 30,000 and this becomes its cost.
Cost to Computer World = $ 30,000
Net Receivables = $ 350,000 – $ 30,000 = $ 320,000
Option 3: Offer Discount
In this option Computer World can provide customer cash offer to collect its receivable in quick time. This offer will motivate customers to purchase goods on cash as company will be giving cash discount. Following is the cost and net receivables to Computer World:
Customers paying cash = 350,000 x 30% = 105,000
Cash discount = 105,000 x 3.5 % = $ 3675
Remaining customers will pay money through easy pay and following is the cost to company:
350,000 – 105,000 =$ 245,000
Easy Pay Commission = 245,000 x 4 %= $ 9800
Total Cost (Discount + Commission) = $ 13,475
Net Receivables = [(105,000 – 3675 = 101,325) + (245,000 – 9800 = 235,200)] = $336,525
From the above calculations it can be observed that option 3 will be generating more receivable to Computer World and has minimum cost related to receivable. Therefore option 3 i.e. cash discount of 3.5% will selected by management.
Following are some factors that need to be considered while making credit sales decision:
- Credit days i.e. days up to credit can be given.
- Collection strength of company i.e. ability of company.
- Amount of credit involved.
- Interest rate to be charged when payment is due.
- Liquidity in company.
- Cost related to credit policy i.e. loss of interest, collection charges, etc.
- Availability of factoring services.
Internal control can be defined as the process which helps and ensures achievement of set objectives and goals related to business research operations. Internal control systems ensure compliance with law, compliance with policies and setting procedures to control business activities. Internal control system utilizes company’s resources in directing, controlling and monitoring business activities. Internal control system also provides risk awareness procedures and facilitates early deduction of risk present in business activities. Strong internal control system facilitates reliable implementation of business policies, systematic and accurate recording of transaction and ensures effectiveness in business activities.
In present case if business or management of Computer World decides to follow up credit and appoints clerk for the same then activities of clerk in controlling and managing credit of company will falls in the ambit of internal control. Since clerk has to follow up collections and manage these collection therefore these activities requires proper control and monitoring in these activities. Since activities or operation undertaken by clerk involves cash and credible information of company therefore some protection must be established. Therefore controlling and monitoring activities of appointed clerk will form part of internal control system of Computer World.
For the purpose of accounting of bad debt there are two methods available with every company i.e. direct write of method and bad debt allowance method.
Under direct write of method direct effect of bad debt when actually occurred will be given. Under this method no provision or protection is given to balance of debtors and balance will get reduced when bad debt occurs. While on the other hand there is another method for accounting or recording of bed debt i.e. bad debt allowance method. Under this method doubtful debt are first estimated and then and provision for allowance is made and at the time of actual bad debt that provision and debtor balance will get reduced. This method fulfils basic accounting principle i.e. marketing principle.
In present case of Computer World, one of its partners Sue had suggested method of recording bad debt as direct method. No, I am not agree with direct method because Computer World are early in its incorporation period and needs to be more cautious about its expenses and losses therefore they shall be make proper arrangements for bad debt and losses. Provision or allowance reserves should be created on some estimation so that protect shall be provided. By following bad debt allowance method more hedging to debtors can be given.
Under allowance method management of company has to make estimates regarding uncollectable amount of debtors or receivables that will not be collected. Since there are many methods of making estimations regarding non-collectability of amount of debtors. Estimations can be on the basis of past trends, industry rate of bad debt and management or expert calculation of rate of bad debt. Under allowance method first of all provision of future expense i.e. bad debt is to be made and this is to be made on trend of uncollectable amount of debtors. But amount of debtors or accounts receivables is to be reduced only when there is actual bad debt. Following entry is to be made:
- Dr. Allowance for Bad Debt
- Cr. Debtors
Above entry will reduce amount of debtors and allowance for bad debt.
Therefore accounting record will not be treated as biased because amount is debtors are reduced only when actual bad debt is occurred. Therefore estimation made on any base will only provide or increase amount of provisions only. Estimation will only become base for future caution or precaution on the basis of past sales or past year trend of bad debt. There is difference in indentifying percentage of bad debt but there is no biasness in recording actual bad debt and in accounting records.
Australian Accounting Standard 108 deals with accounting policies change in accounting estimates and errors. As per the provisions of AAS 108 retrospective statement will be required in order to mentioning or disclosing prior period errors. Estimations are subjective and any error is estimation will require changes since its inception. In this case retrospective statement is required in this behalf. Retrospective statement discloses errors and mistakes done accounting records. Changes related to assets and liabilities are to be reported as adjustments in accounting records. Effect of change in estimates can be recognized in profit or loss account or income statement of the company. Disclosure related to nature of change in amount because of accounting estimates over the period of time is to be reported prospectively not retrospectively. Facts and figures need to be disclosed in financialplanning of the company and no need to present retrospective statement. According to AAS 108 errors in accounting, errors in estimations, error due to accounting estimates are to be presented through retrospective statement. But there is no need to present retrospective statement in case of simple estimation or change in estimation as per Australian accounting standard 108.
Since Computer World is in early business operations and considering which bad debt accounting method be adopted by them. There are two methods i.e. allowance method and direct write off method. Each method has its implications, different characteristics and different accounting treatment. Following are some features of these methods:
Direct Write off Method: Under this method bad debt is recorded as and when it occurs. There is no provision or reserves made for the same. Under this method when bad debt occurs then balance of debtors amount or accounts receivables are reduced. Following accounting entry will be made in the books of accounts:
- Dr. Bad Debt
- Cr. Debtors or Accounts Receivables
Since Computer World is in early stage therefore they are not aware of percentage of bad debt or trend of bad debt therefore they can use direct write off method of debtors.
Allowance Method: Under this first step is to make estimation of percentage of bad debt that may or may not occur during the year. This method provides shield to company in order to manage its bad debts and provide company to manage its debtors in more balanced manner. This method fulfils objective of matching principle. Under this method percentage of sales, industry percentage of bad debt or on some other basis provisions is made for bad debt. At the time of actual bad debt this provision will get reduced with the amount of debtors or accounts receivables. Following are two entries are required under this situation:
At the time of creation of provision:
- Dr. Income Statement
- Cr. Allowance for Doubtful Accounts receivables
At the time of actual bad debt:
- Dr. Allowance for Doubtful Accounts receivables
- Cr. Debtors or Account Receivables
In this manner debtors amount will get reduced and amount available in allowance for Doubtful accounts receivables get utilized. From the above comparison of two bad debt accounting method. It can be seen that both methods can be used by Computer World for its debtors and bad debt management. Since Computer World is newly incorporated firm therefore direct write off method can be used and on the other hand Computer World can use industry rate of estimation for allowance method therefore this method can also be used for better presentation.
The Accounting Assignment it can be concluded that every company or partnership firm has to manage its credit sales and its debtors against such credit sales. Credit sales decision shall consider many factors like interest rate, credit days, etc for better management of credit sales. Collection process of company will be included in the process of internal control. Both direct write off method and allowance method has its own advantages and disadvantages for its application for better accounting treatments. Under allowance methods method estimates made for the purpose of provision to be made is main part. Change in estimate does not require retrospective statement. It is required when only when there is any prior error in the accounting records.
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