Question

1. What are the differences between a merchandising and service company?

2. How are bad debts accounted for under the direct write-off method? What are the disadvantages of this method?

3. Define the six principles of control activities and give an example of each. An example may include how to prevent fraud or a type of fraud that could occur if these activities are not in place.

Please give examples!! thanks for whoever help this question out :)

Answer 1

A merchandising company generates income by selling goods to its customers. However a service company produces income by providing services to their customers Differences Merchandising company Revenues Sales revenue Example: Selling price of merchanding inventory Service company Service Revenue Example: Fees received, Rents received, Interest income Cost of goods sold and operating expenses Expeses Only operating expenses Rent, office supplies, taxes, utilities, insurance Rent, office supplies, taxes, utilities, insurance

Direct write-off method: This method requires an entity to recognize the bad debt expense once it occurs (which maybe after several years from the time of sale). The following entry is passed to record the bad debt expense for the year: Here are the accounting entries for direct write-off method: Bad debt expense Accounts receivable It is affected only the bottom line of income in the current period. This is because expenses are recognized in this period. It is probably against with the matching principle. Dr Disadvantages of direct write-off method: The major disadvantage of this method is that it fails to maintain the financial statements as per the generally accepted accounting principles (GAAP). It goes against the accrual system of accounting and violates the matching principle as well as the prudence concept The matching principle states that expenses in an income statement shall relate to the revenue it has generated.

• • • • In the case of direct write-off method, we write off a bad debt expense when all means of recovering the money have expired. This happens after years from the time of sale. This means that the bad debt expense is expensed out in a later year instead of being expensed out as a provision for doubtful debt in the accounting period its related sales had occurred. A violation of accounting principles means that the financial statements are not portraying a true and fair view of the business. Similarly, the prudence concept states that an expense shall be recognized as soon as it is expected or is probable. In the direct write-off method, we write off accounts receivable after the bad debt has occurred instead of expensing out the doubtful debts every year that are expected at the time of sale. Another major problem is that the direct write-off method is an aggressive way of reporting bad debts since the profits are overstated in the early years since no provision is expensed out. As the time passes, the bad debt amount becomes so huge that it ends up vastly understating the profit or net income of the company. •

1 Establishment of responsibility 2 Segregation of Duties Assigning responsibility to specific employees. Control is most effective when only one person is responsible for a given task Different individuals should be responsible for related activities. The responsibility for record keeping for an asset should be separate from the physical custody of an asset Control systems should require that employees promptly forward source documents for accounting entries to the accounting department. This control measure helps to ensure timely recording of the transactions 3 Documentation procedures 4 Physical Control Relates to the safeguarding of assets and enhance the accuracy and reliability of the accounting records 5 Independent internal verification Companies should verify records periodically or on a surprise basis, An employee who is independent of the personnel responsible for the information should make the verfication Discrepancies and exceptions should be reported to a management level that can take appropriate corrective action Companies should bond employees who handle cash rotate employees duties and require employees to take vacations, and conduct thorough background checks 6 Human Resource Control