ATC 7-7 Ethical Dilemma: How Bad Can It Be?

Accounting for Receivables

ATC 7-7 Ethical Dilemma: How Bad Can It Be?

Alonzo Saunders owns a small training services company that is experiencing growing pains. The company has grown rapidly by offering liberal credit terms to its customers. While his competitors require payment for services within 30 days, Saunders permits his customers to delay payment for up to 90 days. Saunders guarantees satisfaction, and if a customer is unhappy with the service, the customer is not obligated to pay. Saunders works with reputable companies, provides top-quality training, and rarely encounters dissatisfied customers.

However, the long collection period has caused a cash flow problem. Saunders has a $100,000 accounts receivable balance but needs cash to pay current bills. He has recently negotiated a loan agreement with National Bank of Brighton County that should solve his cash flow problems. The loan agreement requires Saunders to pledge his accounts receivable as collateral. The bank has agreed to loan Saunders 70 percent of the receivables balance, which would give him access to $70,000 in cash. Saunders estimates that he needs approximately $60,000.

On the day Saunders was to execute the loan agreement, he hears a rumor that his largest customer is experiencing financial troubles and may declare bankruptcy. The customer owes Saunders $45,000. Saunders immediately calls the customer’s chief accountant and learns "off the record" that the rumor is true. The accountant tells Saunders that the company’s net worth is negative and that most of its assets are pledged as collateral for other bank loans. In his opinion, Saunders is unlikely to collect the balance due. Saunders' immediate concern is the impact of this situation on his loan agreement with the bank.

Saunders uses the direct write-off method to recognize uncollectible accounts expense. If he removes the $45,000 receivable from the collateral pool, only $55,000 of receivables remain, reducing the available credit to $38,500 ($55,000 × 70%). Additionally, recognizing the uncollectible accounts expense would adversely affect his income statement, possibly causing the bank to further reduce the available credit by lowering the percentage of receivables allowed under the loan agreement. Saunders knows he must attest to the quality of the receivables at the time of the loan, but because the information he obtained about the bankruptcy was "off the record," he believes he is not obligated to recognize the uncollectible accounts expense until the receivable is officially uncollectible.

Required:

a. How are income and assets affected by the decision not to act on the bankruptcy information?
b. Review the AICPA’s Articles of Professional Conduct (see Chapter 2) and comment on any of the standards that would be violated by the actions Saunders is contemplating.
c. Identify the elements of unethical and criminal conduct recognized in the fraud triangle (see Chapter 2), and explain how they apply to this case.

ATC 7-8 Research Assignment: Comparing Whirlpool Corporation’s and Papa John’s Time to Collect Accounts Receivable

Using the most current annual reports or Forms 10-K for Whirlpool Corporation and Papa John’s International, Inc., complete the requirements that follow. You can obtain the Forms 10-K using either the EDGAR system, following the instructions in Appendix A, or from the companies’ websites. Annual reports are available on the companies' websites.

Required:

a. What was Whirlpool’s average days to collect accounts receivable? Show your computations.
b. What percentage of accounts receivable did Whirlpool estimate would not be collected?
c. What was Papa John’s average days to collect accounts receivable? Show your computations.
d. What percentage of accounts receivable did Papa John’s estimate would not be collected?
e. Briefly explain why Whirlpool would take longer than Papa John’s to collect its accounts receivable.

ATC 7-9 Spreadsheet Assignment: Using Excel

Set up the following spreadsheet comparing the Vong and Crist companies.

Required:
For each company, compute the following:

• Gross Profit
• Gross Profit Percentage
• Net Realizable Value
• Accounts Receivable Turnover
• Average Days to Collect