Estimating uncollectibles, financial ratios, and loan agreements

Excerpts from the 2011 financial statements of Finley, Ltd., a service company, follow:

Fees earned

$240,000

Accounts receivable

68,000

Allowance for doubtful accounts

3,400

Total current assets

105,000

Total current liabilities

65,000

Net income

15,000

Dividends declared

5,000

Bad debt expense

3,400

Auditors from Price and Company reviewed the financial records of Finley and found that a credit sale of $10,000 (for services rendered), which was included in the fees earned amount above, should not have been recognized until January 20, 2012. The auditors also noted that a more reasonable estimate of future bad debts would be 10 percent of the accounts receivable balance. The auditors have informed Finley"s management that the audit opinion will be qualified if Finley does not adjust the financial statements accordingly. REQUIRED:

a. Compute the effect of the auditors" recommended adjustment on the 2011 fees earned, accounts receivable, allowance for doubtful accounts, current ratio, working capital, and net income reported by Finley.

b. Assume that Finley has a loan agreement with a bank, requiring it to maintain a current ratio of 1.5 and limiting its annual dividend payment to 50 percent of net income. How might these restrictions have influenced the reporting decisions of Finley"s managers?

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