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The annual sales revenue for an enterprise was $ 2 million in the current year (just ended). Its trade receivables are 5% of revenue.
The enterprise wishes to make an allowance for doubtful debts of 4% of trade receivable, which would make the allowance one-third higher than the existing allowance.
How will the profit for the period be affected by the change in allowance?
The allowance required at the end of the year is 4% x 5% x $2 = $4,000
If this is to be 1/3 more that the allowance at the start of the year, then it must be 4/3 times the existing allowance. So the existing allowance must be 3/4 x $4,000 = $3,000.
So the increase in allowance needed is 4,000 – 3,000 = $1,000.
Therefore the profit will be reduced by the expense of increasing the allowance of $1,000.
(The free lecture on irrecoverable and doubtful debts will be useful for you)
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