Question

Margaret is the manager of a medium-size company. A few years ago, Margaret persuaded the owner to base a part of her compensation on the net income of the company. Each December she estimates year-end financial figures in anticipation of the bonus she will receive. If the bonus is not as high as she would like, she offers several recommendations to the accountant for year-end adjustments. One of her favorite recommendations is for the controller to reduce the estimate of doubtful accounts. 1. What effect does lowering the estimate for doubtful accounts have on the income statement and balance sheet

Answer 1

Answer:

• Overstates the Net Income in Income statement

• Overstates Accounts Receivable in Balance Sheet

Explanation:

The estimate for doubtful debt serves a very important role in accounting because it ensures that a company is ready for the possibility of bad debt occurring. Without it, a company would have to deal with bad debts as they come and this can damage profit projections.

It is treated as an expense in the business so in reducing it, Margaret is reducing the expenses which will increase the net income. This net income will be overstated however because the estimate for doubtful accounts should be higher than it is.

Estimates for doubtful debt are deducted from the Accounts Receivable balance in the Balance sheet so if it is reduced, the Accounts Receivable balance will not be reduced as much as it should be which would mean that is is overstated or higher than it should be.