A firm maintains an allowance for doubtful debts at 5% of trade receivables. This year, trade receivables were 8,000, which represented a 20% decrease from the previous year. How will this change affect the current year's profit?

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SSC Financial and Cost Accounting P-1 QUESTION #6081

Question 1

A firm maintains an allowance for doubtful debts at 5% of trade receivables. This year, trade receivables were $8,000, which represented a 20% decrease from the previous year. How will this change affect the current year's profit?

Decrease by $100
Decrease by $400
Increase by $100✔️
Increase by $400

Correct Answer Explanation

1. Current Receivables = $8,000. Current Allowance = $8,000 $\times$ 5% = $400.
2. Last Year Receivables = $8,000 / 0.80 = $10,000. Last Year Allowance = $10,000 $\times$ 5% = $500.
3. Change = $500 - $400 = $100 reduction in allowance.
A reduction in allowance is credited to the income statement, thus increasing profit by $100.

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