Question one
Many firms with ambitions of increasing their market share may offer goods and services on credit. Some of the customers offered credit may not settle their accounts. This results to bad debts and must be accounted for in company’s books of account. There are two ways of accounting for bad debts i.e direct write off method and allowance method. In direct write off method bad debts are recognized only when the company is sure that the customer will never settle his or her account i.e. the debt is uncollectable. To account for the bad debt the company accountant will provide a debit entry in bad debts account and a corresponding equal credit entry in account receivable account. This amount is subsequently debited in profit and loss account. Therefore this method is most suitable for determining bad debt allowable expense for calculating firm’s taxable income.
The bad debts are therefore recognized in a year which they prove to be uncollectable but not in the year when the credit sales were made. This contravenes the matching principle which requires all expense of a given trading period to be matched with the year revenue. It therefore, makes many companies to use direct write off method in submitting tax returns but not in presentation of financial statement. To avoid the above mentioned demerit of contravening matching principle when preparing financial records, accompany uses the allowance method. Unlike direct write off method, in allowance method a percentage of sales are set aside as an adjustment for bad debts which may result. The percentage is determined out of companies past experience however, a new company relies on industries average. This adjustment is known as allowance for doubtful debts. Therefore, this amount is subtracted from account receivable to get net releasable receivables (Reimers, 2007).
References
Reimers, J. L. (2007). Financial accounting. Upper Saddle River, N.J.: Prentice Hall.
Question two
Intangible assets should be recognized and accounted for in accordance with IAS 38. They are classified as either finite or indefinite life assets; this is based on how long they will remain beneficial to the firm. The ones under finite life are expected to benefit the firm for a stipulated period of time unlike the indefinite ones. IAS 38.97 requires finite intangible assets to be amortized over its useful life. The amortization method adopted should reflect the benefits accruing from the asset (Intangible assets. (1998). On the other hand, intangible asset with indefinite useful life should not be amortized. IAS 38.109 requires this asset to be reviewed yearly to determine whether it has changed to finite life in accordance events and circumstances surrounding its usefulness. Failure to amortize intangible asset over its legal period means that when the assets becomes non beneficial to the company then it will be written off in that year. This will go against the matching principle which calls for financial records to be prepared matching yearly revenue from an asset with expenses associated with the asset.
References
Intangible assets. (1998). London, U.K.: International Accounting Standards Committee.
Question three
Percentage of sale and percentage of receivable methods are consistent with the matching accounting principle. Percentage of receivable method estimates bad debts by multiplying the percentage allowance for doubtful debts with credit sales only. On the other hand percentage of sales method multiplies the percentage with total sales. It is up to management to decide which method to adopt in providing this estimate, because, both of them are in accordance with GAAPs. However, one may choose percentage of sales method for it will give a high amount to be set aside for bad and doubtful debts than percentage of receivable method (Reimers, 2007). In addition, in percentage of receivable the allowance is obtained from an analysis of individual customer accounts i.e an analysis known as aging accounts receivable. This is a very tedious process because account of every customer should be scrutinized. This is because the amount of adjusting entry is got by subtracting existing balance in the allowance account from the required balance.
References
Reimers, J. L. (2007). Financial accounting. Upper Saddle River, N.J.: Prentice Hall.
