Question

‘‘Just one,’’ John saidand it’s only an idea that you might wantto pitch to the management

team along with these other changes. We have used the percent ofaccounts receivable method to

calculate our Allowance for Bad Debt for several years. But wedon’t have to use that method.’’

‘‘What do you mean?’’Elsa asked. ‘‘Isn’t the percent of accountsreceivable method one of the

best ways to calculate the Allowance?’’

‘‘Technically, yes, it is. However, we recently hired a newcredit manager who has improved

our collections and tightened our credit policy for newcustomers. Because of these improvements,

we might not have to use the percent of accounts receivablemethod. Instead, we could switch back

to the percent of sales method that we used previously. Byswitching from using 12 percent of

accounts receivable to 2 percent of credit sales, we wouldreduce our allowance for bad debts

and our bad debt expense. That would offset some of thesenegative changes we have just discussed.’’

‘‘What were credit sales for the year?’’ Simon asked.

‘‘About $1.25 million, and accounts receivable had an endingbalance of $600,000 after we

wrote off $30,000 of uncollectible accounts. We wrote off almost$50,000 the year before, so our

collections really have improved. Honestly, I don’t think thatwe’d lose information quality by

switching methods. We don’t really have to use any specificmethod for estimating bad debt

expense. I think we could make a case for the more relaxedestimation method, and I think the

positive effect of the change on net income might help themanagement team accept some of these

other adjustments.’’ Elsa jumped in.

‘‘I don’t see any problem with that.’’ Simon frowned.

‘‘I’m not sure I like the idea of changing methods solely tooffset the negative

effects of these other adjustments. But go ahead and calculatehow switching methods would affect

our bad debt expense. We’ll meet again tomorrow morning, afterI’ve talked with Jane and Doug

about how to handle these issues.’’

Estimate 1	Estimate 2
Current Sales Price	$750	$600
Historical Cost	$850	$850
Replacement Cost	$700	$500
Disposal Cost	$65	$70
Typical Markup	$200	$175
Units in Inventory	62	62

a. Based on the information provided in the take, calculate thewrite-down that would be necessary using the first set ofassumptions.

b. Based on the information provided in the table claculate thewrite-down that would be necessary using the second set ofassumptions.

c. Assuming that Frosty Co.'s management team decided to use thefist set of estimates, what correcting entries wouldd need to bemade to write down inventory? (assume that Frosty Co. uses thedirect write-off method)

d. What correcting entries would need to be made to write downinventory if the team decided to use the second set ofestimates?

e. What would be the net effect of each of these inventoryadjustments on net income? what would be the net effect on EPS?