Question

Issue 4: Mike Walnut Receivable Mike Walnut Company (Mike Walnut) owes ACE $82,000 for a computer system installation that was purchased in March of 2018. Mike Walnut has run into financial difficulties due to dramatic decreases in the selling price of walnuts during recent years. In August of 2018, Ace President Laura Watson, and Controller Jane Walls established a repayment schedule in which Mike Walnut would repay $10,000 per month (plus interest). While the first payment was made in September (bringing the debt down from $92,000 to $82,000), no further payments have been received. (Mike Walnut has continued to make small purchases from ACE on a "cash" basis only.) Your discussion with management indicates that Mike Walnut received a "going concern" modification from its auditors for the year-ended 12/31/17 (audit report dated 2/22/18). The going concern modification arose due to a question concerning whether Mike Walnut could obtain new financing when needed, however, Mike Walnut's layoff of 1/3 of the company's employees resulted in the company breaking even for the year ended 12/31/17. Mike Walnut has discussed filing for bankruptey with bankruptey legal counsel but at this point believes it is unnecessary. If it becomes necessary, counsel suggests that creditors should not expect to receive more than 50 cents on the dollar. Management has suggested to you that 70 cents on the dollar is more likely if bankruptcy ensues. Your analysis at the date of Mike Walnut's audited annual statements (12/31/17) indicates that if bankruptcy is declared, a recovery of 50-60 cents on the dollar is likely. Yet, it's difficult to know what the situation will be in the future. The sales agreement for the computer system allows ACE to repossess the equipment at any time prior to bankruptcy. However, because the equipment is used and specific to Mike Walnut's applications, management believes that the equipment could be sold for a (net) of between $20,000 and $30,000. Management points out that such an action would not be considered positively by either Mike Walnut or a number of other companies that ACE is attempting to attract as clients. Accordingly, ACE has resisted this option and does not intend to pursue it at this time. Your analysis of the interim statements (unaudited) reveals that Mike Walnut operated at a slight profit during the first quarter and that walnut prices have increased approximately 15 percent. However, experts disagree widely as to future walnut prices as there is some concern that a significant increase in walnuts from India may enter the US market. Finally, Mike Walnut's management, although noncommittal on details, suggests that it believes that it will be able to continue repayments on the debt within the "next few months." But your feeling is that it is probable that Mike Walnut will be forced to file for bankruptcy. No allowance for this account is currently included in the allowance for doubtful accounts. What, if any, loss reserve (and/or note disclosure) should be reflected in the financial statements?

Answer 1

A note should be disclosed in the financial statements about the chances of bankruptcy being filed by Mike Walnut Company, as there is a significant receivable of $ 82,000. Also, the Company should make a provision for loss on doubtful debts, based on the recovery probability, considering the same as management estimate ranging from 40-50 cents per dollar and the provision made should be disclosed as a separate line item under trade receivables and the same should be reduced from trade receivables.