Chapter 5, Problem 5.7AP

Overestimating future uncollectible accounts (LO5–3, 5–5)

Humanity International sells medical and food supplies to those in need in underdeveloped countries. Customers in these countries are often very poor and must purchase items on account. At the end of 2018, total accounts receivable equal $1,300,000. The company understands that it’s dealing with high credit risk clients. These countries are often in the middle of a financial crisis, civil war, severe drought, or some other difficult circumstance. Because of this, Humanity International typically estimates the percentage of uncollectible accounts to be 35% (= $455,000). Actual write-offs in 2019 total only $300,000, which means that the company significantly overestimated uncollectible accounts in 2018. It appears that efforts by the International Monetary Fund (IMF) and the United Nations (UN), and a mild winter mixed with adequate spring rains, have provided for more stable economic conditions than were expected, helping customers to pay on their accounts.

Required:

  1.    Record the adjustment for uncollectible accounts at the end of 2018, assuming there is no balance in Allowance for Uncollectible Accounts at the end of 2018 before any adjustment

  2.    By the end of 2019, Humanity International has the benefit of hindsight to know that estimates of uncollectible accounts in 2018 were too high. How did this overestimation affect the reported amounts of total assets and expenses at the end of 2018? Ignore tax effects.

  3.    Should Humanity International prepare new financial statements for 2018 to show the correct amount of uncollectible accounts? Explain.