Question

Which of the following items should alert the analyst to the potential for manipulation when analyzing accounts receivable and the allowance for doubtful accounts?

a. Accounts receivable is growing at a large rate and the allowance for doubtful accounts is decreasing.
b. Sales, accounts receivable and the allowance for doubtful accounts are all growing at approximately the same rate.
c. An analysis of the "Valuation and Qualifying Accounts" schedule required in the Form 10-K reveals that the amounts recorded for bad debt expense are close in amount to the actual amounts written off each year.
d. A company lowers its credit standards and also increases the balance in the allowance for doubtful accounts.

Answer 1

The correct answer is option C. The option that should raise concern for manipulation when analyzing accounts receivable and the allowance for doubtful accounts is Option C. An analysis of the 'Valuation and Qualifying Accounts' schedule reveals that the recorded bad debt expense matches the actual write-offs each year.

Step-by-step explanation:

In analyzing accounts receivable and the allowance for doubtful accounts, there are certain items that should alert the analyst to the potential for manipulation:

1. Option A: Accounts receivable is growing at a large rate and the allowance for doubtful accounts is decreasing. This situation could indicate that the company is inflating its sales revenue and intentionally underestimating the amount of bad debt.
2. Option C: An analysis of the 'Valuation and Qualifying Accounts' schedule required in the Form 10-K reveals that the amounts recorded for bad debt expense are close in amount to the actual amounts written off each year. This suggests that the company may be manipulating the bad debt expense account to match the actual write-offs, potentially understating the true allowance for doubtful accounts.
3. Option D: A company lowers its credit standards and also increases the balance in the allowance for doubtful accounts. This combination could indicate an attempt to offset the increase in potential bad debt with an increase in the allowance, disguising the impact on the financial statements.

Based on these considerations, the correct option that should alert the analyst to the potential for manipulation when analyzing accounts receivable and the allowance for doubtful accounts is Option C: An analysis of the 'Valuation and Qualifying Accounts' schedule required in the Form 10-K reveals that the amounts recorded for bad debt expense are close in amount to the actual amounts written off each year.