The Assignment
Harry, Sue and Lee are in partnership and started a new business called "Computer World". Initially they are selling a single notebook item which they purchase from a renowned manufacturer. Although in first year of operations, they were reluctant to extend credit, in their second year of operations they are exploring if the business can extend credit to improve sales. The partners are in dilemma whether the business should follow up the collection itself or make other arrangements. One option is to make sales by extending credit through "Easy Money", a credit union. If a customer makes a purchase through "Easy Money", the business will get immediate cash subject to 4 percent Easy Money's commission to be deducted from the gross amount. The second option is to follow up the sales and collection by the business itself. The third option is to offer a discount of 3.5 percent to customers who will make cash purchases and do not pay by credit card and remainder will obtain credit through Easy Money. The business has following hypothetical figures available for the year: Projected credit sales $350,000; projected new staff salary if the business wants to follow up the collection $30,000; 30 percent of customers will pay cash.
Requirement 1: What option the business should choose (show your calculation). Are there any other factors that need to be considered while making a credit sales decision?
Requirement 2: If the business decides to follow up the credit by the business itself and appoints a clerk to follow up the collection, is there any issue to consider as part of internal control?
The partners are all aware that simply extending credits by firm itself will lead to some bad debt expenses and they are in dilemma as which accounting method to follow to record the bad debts. All the partners have studied a basic accounting course at a university. Sue argued that the business should follow the ‘Direct Write Off' method as it allows the recording of the ‘Bad Debt' as and when it occurs.
Requirement 3: Do you agree with Sue? Why or why not?
On their discussion about bad debt recording Harry argues that the ‘Allowance Method' is problematic as it requires the making of estimates and estimates are different under different estimation techniques.
Requirement 4: Please provide explanations as how these estimates may not result in any undue bias in accounting record.
On their discussion about bad debt recording Harry further argues that if the business follows the ‘Allowance Method', the business should produce a "Retrospective Statement" to show the difference in estimation of bad debt.
Requirement 5: Please explain whether a "Retrospective Statement" will be required following AASB 108.
Requirement 6: To mediate, Lee argues that the business should be able to use both ‘Direct Write Off' and the "Allowance Method" to record the bad debt. Discuss if it is true.