Kelly Steinman is the manager of a medium size company. A few years ago, Steinman persuaded the owner to base a part of her compensation on the net income the company earns each year. Each December she estimates year-end financial figures in anticipation of the bonus she will receive. If the bonus is not as high as she would like, she offers several recommendations to the accountant for the year-end adjustments. One of her favorite recommendations is for the controller to reduce the estimate of doubtful accounts.


a. What effect does lowering the estimate for doubtful accounts have on the income statement and balance sheet?

That effect that lowering the estimate for doubtful accounts will have on the income statement and balance sheet is it will give a false impression of what is to be expected by the company in the next year. Because of the action taken, the company’s expectations of its net income and its estimate of doubtful accounts will be overestimated resulting in a domino effect of inaccurate decisions.

b. Do you think Steinman’s recommendation to adjust the allowance for Doubtful accounts is within her right as a manager, or do you think this action is an ethics violation? Justify your response.

This is definitely an ethics violation. The current year allowance has the effect of reducing net income so reducing the allowance adds to net income which in turn will increase Kelly’s bonus.



c. What type of internal control (s) might be useful for this company in overseeing the manager’s recommendations for accounting changes

a. I think they're probably just looking for the mathematical affect it would have on the statements. I don't think anyone is really "expecting" anything of the company next year because of a bad debt allowance account. :-) I think they're just meaning, what happens to the statements this year. Basically, what you said in (b). Although (b) is not stated quite correctly. It's not really the allowance that is affecting the net income -- it's the bad debt expense. She's reducing the amount she puts into the allowance, which is the same as the expense recorded. If that's reduced, income shows as being higher. What does it also do to the balance sheet?

As for (c), you haven't made an attempt at that one yet, and I'm not going to just give you answers. Besides, there could be different things that could be done.