Question

You have recently been hired as the assistant controller for Stanton Industries, a large, publicly held manufacturing company. Your immediate superior is the controller who, in turn, is responsible to the vice president of finance. The controller has assigned you the task of preparing the year-end adjusting entries. In the receivables area, you have prepared an aging of accounts receivable and have applied historical percentages to the balances of each of the age categories. The analysis indicates that an appropriate balance for the allowance for uncollectible accounts is $180,000. The existing balance in the allowance account prior to any adjusting entry is a $20,000 credit balance. After showing your analysis to the controller, he tells you to change the aging category of a large account from over 120 days to current status and to prepare a new invoice to the customer with a revised date that agrees with the new aging category. This will change the required allowance for uncollectible accounts from $180,000 to $135,000.

1. What is the effect on income before taxes of the change requested by the controller?

Answer 1

Changing the required balance of the allowance for uncollectible accounts from $180,000 to $135,000 increases the income before taxes by $45,000 since a smaller expense will be recognized in the income statement.

Step-by-step explanation:

The effect on income before taxes of the change requested by the controller would be an increase. Initially, the allowance for uncollectible accounts needed to be set at $180,000 based on your aging analysis. However, after the controller's adjustment, which is not aligned with actual aging information, this allowance is reduced to $135,000.

The difference between the two allowances is $45,000. Because the allowance for uncollectible accounts is a contra-asset account that decreases the total accounts receivable on the balance sheet, lowering the allowance increases the net value of accounts receivable, which subsequently increases income before taxes.

Thus, with a $20,000 credit balance already present in the allowance account, the initial required adjustment would have been an increase of $160,000 to reach the necessary $180,000 balance ($180,000 needed - $20,000 existing).

After the controller's adjustments, only an additional $115,000 ($135,000 needed - $20,000 existing) is required, resulting in a $45,000 less expense recognized in the income statement, which in turn boosts the income before taxes by the same amount.