The rationale is based on the Generally Accepted Accounting Principles (GAAPs) and the matching principle. The matching principle requires that expenses incurred relative to the sales be recorded in the same accounting period as revenue earned. Thus, the rationale used in recording bad debts was the allowance method, and the estimation of the figure was through the accounts receivable aging method. The allowance is established by recognizing the provision for bad debts on the same accounting period’s income statement as the original sale. The accounts receivable aging method estimates the allowance for bad debts by grouping all outstanding accounts receivable by age (Kuznetsova, 2019). The likelihood of default is dependent on the length of time; thus, percentages based on age are applied to each specific group. The aggregate results of all groups represent the provision for bad debts.
According to Kuznetsova, misstatement of provision for doubtful debts leads to overstatement of accounts receivables and revenue, affecting both the income statement and balance sheet. The provision of bad debts is critical in determining the true financial position of a company. Bad debts are reported as expenses in the income statement, thus reduce a company’s revenue, therefore understating bad debts provision expense leads to overstatement of net income and misstatement of shareholder’s equity. The shareholder’s equity is the remainder of assets available to shareholders after the company pays all its liabilities. Shareholders’ equity is directly proportional to net income; thus, miscalculation of net income leads to incorrect shareholders’ equity account. An inaccurate income statement leads to a false financial position of a company. Doubtful debts are recorded as assets in the balance sheet; thus, their recognition on the balance sheet leads to reduced accounts receivable. The contra- asset entry understates the uncollected amounts leading to an overstatement of debtors and ultimately the potential income.
The ethical dilemma in play is the pressure to report manipulated accounts and the obligation to report the company’s real financial situation. The ethical considerations revolve around the Sarbanes-Oxley Act in 2002, which dictates that public traded companies’ management is required to disclose the true and fair view of the company’s accounts to the shareholders through transparency in reporting and accountability to those in executive positions (Sherman and Young, 2016). My first option available is to report the misstated accounts to shareholders and become open to civil liability. My second option is to report the controller to the top management and relevant authorities regarding the fraud. The Sarbanes-Oxley Act in 2002 protects whistleblowers employees who report fraud to appropriate authorities. My responsibility as an assistant controller in charge of accounting is to report the true and fair view of financial statements according to the GAAPs.
Internal stakeholders refer to individuals and parties within an organization, while external stakeholders represent outside parties affected by business activities. The critical internal stakeholders include; owners and management, while the key external stakeholders include creditors and potential investors. The negative impact of reporting the correct financial statement is borne by management. Compensation of corporate executives is dependent on the financial performance of a company; thus, the reduction of income leads to reduced compensation packages for top management such as the controller.
Owners, potential investors, and creditors will be negatively affected since the reports will paint the firm’s wrong financial position. Owners’ interest in financial statements is to assess the returns on their investment paid through dividends, where the higher the net income, the higher the dividends. Manipulating the net income leads to wrong corporate decisions by owners and investors as their decisions are based on false statements. Creditors, including financial institutions, are also misled by the company’s false financial position, which ultimately leads to loan defaults.
Kuznetsova, O. N. (2019). Accounting and Control of Doubtful Debts Reserves. Finansovyj žhurnal—Financial Journal, (4), 88-101.
Sherman, H. D., & Young, S. D. (2016). Where financial reporting still falls short. Harvard business review, 94(7), 17.