Chapter 5, Problem 5.5AP

Compare the direct write-off method to the allowance method (LO5–3, 5–6)

In an effort to boost sales in the current year, Roy’s Gym has implemented a new program where members do not have to pay for their annual membership until the end of the year. The program seems to have substantially increased membership and revenues. Below are year-end amounts.

	Membership Revenues	Accounts Receivable
Last year	$ 150,000	$ 6,000
Current year	450,000	170,000

Arnold, the owner, realizes that many members have not paid their annual membership fees by the end of the war. However, Arnold believes that no allowance for uncollectible accounts should be reported in the current war because none of the nonpaying members’ accounts have proven uncollectible. Arnold wants to use the direct write-off method to record bad debts, waiting until the end of next year before writing off any accounts.

Required:

  1.    Do you agree with Arnold’s reasoning for not reporting any allowance for future uncollectible accounts? Explain.

  2.    Suppose that similar programs in the past have resulted in uncollectible accounts of approximately 70%. If Arnold uses the allowance method, what should be the balance of Allowance for Uncollectible Accounts at the end of the current war?

  3.    Based on your answer in Requirement 2, for what amount will total assets and expenses be misstated in the current war if Arnold uses the direct write-off method? Ignore tax effects.