Abitibi Ltd Is Trying to Obtain a Loan from the Bank

Question

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The Answer is A) The bank is willing to lend you money, but they want to use your accounts receivables as collateral.If you default on the loan they will try to collect the accounts receivable to pay the interest and principal outstanding.They only want to accept as collateral the receivables that are relatively current (not too far overdue).The longer a receivable is overdue the greater the risk that it will never be collected.The bank does not want to assume too great a risk.The bank wants you to prepare a list of all accounts that are outstanding and categorize them by how long they have been outstanding.That is an aging schedule.That way they can clearly see how quickly you collect your accounts receivable and how risky they are.
B) As a private company you do not have to follow GAAP, and your method of recording bad debts by reversing the sale made have made sense to you, but it is not the usual way of doing it.The bank will prefer you to use a more generally acceptable method of recording bad debts so it can compare your account to others.
C).Bad debts should be estimated in the period the sale is made, that is, better matching of the cost of offering credit to the sales the credit generates.It should also be recorded as an expense and not as a reversal of a sale.If you reverse the sale it would distort your cost of goods sold or gross margin ratio and it does not reflect your economic activity of the period.You did make the sale, you just didn't collect it.The cost should be reflected as an expense, a cost of offering credit.
D) There are two methods of estimating bad debts, the percentage of credit sales method and the percentage of receivables method.The percentage of credit sales method estimates the expense as a percentage of your credit sales and provides for good matching of the expense and revenue.The percentage of receivables method looks at the balance in the accounts receivable account and estimates how much of those you don't think you will collect, based on how long they have been outstanding.It focuses more on reporting the receivables at their net realizable value on the balance sheet.
E) You should use the percentage of the receivables method.The bank is going to require you to prepare an aging schedule and that is the basis of the method.It would be simplest and more consistent to use that for your estimates.

Abitibi Ltd Is Trying to Obtain a Loan from the Bank

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