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?
