Bob and Larry were finishing the financial statements for

their
Bob and Larry were finishing the financial statements for their business when they saw the net
income for the year was not going to be as high as they had hoped. Concerned that the bank
would question the lower reported net income, Bob suggested that they reduce the percentage
used to estimate Doubtful Accounts for the current year from 5% of credit sales to 1 % of credit
sales. Larry quickly pointed out that for the last seven years, the bad debts always
approximated 5% of the total credit sales. Bob then said that the key was simply that an
“estimate” was used to compute the bad debt expense, so why not simply change the
percentage from the “5% estimate” to a “1% estimate”? Larry was concerned because the
change was not due to new business information; rather it was due to pressure to increase the
current year profit by reducing the amount of bad debt expense currently included in the income
statement. He told Bob that the current year credit sales were $6,587,000 and the Bad Debt
Expense should be 5% or $329,350, not 1% or $65,870, because they could expect that over
the next fiscal year approximately $329,000 of Accounts Receivable would end up as
uncollectible. Bob pointed out, however, that by only using a 1 % estimate the current year net
income would be much higher since the amount of Bad Debt Expense would only be $65,870
instead of the larger $329,350. He also noted that the allowance account would also be reduced
so the net Accounts Receivable on the balance sheet would be larger as well. Besides, Bob told
Larry that they could worry about it in the next fiscal year. Larry told Bob that the bank would
find out what they had done, to which Bob said there would be no problem; they could just say
they made a mistake in their estimate.Would it be unethical to change the percentage used to
compute the current year’s Bad Debt Expense? Would it be acceptable to change the
percentage amount if the change was disclosed? Would it be acceptable if they compromised
and used 3%? If they had used a new screening method to determine the creditworthiness of
customers and, as a result, they were certain that the bad debts would be drastically reduced,
could they change the percentage amount used? What do you think would happen if they used
the 1 % of credit sales for the current year financial statements? What would you
recommend?View Solution: Bob and Larry were finishing the financial statements for their
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