Question

Afirm has consistently adjusted its allowance account at the end of the fiscal year by adding a fixed percent of the period's sales on account. After seven years, the balance in Allowance for Doubtful Accounts has become very large in relationship to the balance in Accounts Receivable. Give two possible explanations.

Answer 1

Answer: Please refer to the explanation below for the full answer.

Explanation: The allowance for doubtful debts acts as a holding account for any accounts in the Accounts Receivable that might not be collected. In other words any accounts that are written off as bed debts will be removed from this account.

Reasons why this account can become very large in relation to the Accounts receivable are:

1. An incorrect or high percentage may be used to estimate accounts that may be written off as bad debts. This can lead to an unnecessarily high allowance for doubtful debts account.

2. There might be an error in the overall calculations done.

3. A large amount of old bad debts that have not been removed from this account may still be sitting in the account.

4. Fraud