Overview
The Chan and Baaz partnership is in the import and sales business and is less profitable now than in the past.
It is in its last year and will become Chan's sole proprietorship next year. Baaz is entitled to half the current
year's profits and his book equity value at the end of the year. Chan has an obvious incentive to minimize
income and net assets in these circumstances. Baaz would be interested in fair evaluation of operating
performance and net assets, and in ensuring that the entity remains viable, since he is not entitled to a payout
for five years.
Issues
The partnership has new/questionable policies for
1. Allowance for doubtful accounts: percentage of sales versus specific identification
2. Write-off of obsolete inventory
3. Amortization policy for new computer equipment
Analysis
1. Allowance for doubtful accounts
An allowance for doubtful accounts must be established, but several approaches to establishing the
appropriate amount are allowed under GAAP. In the past, specific identification has worked well, but
percentage of sales is objective and also acceptable. It is a concern that the percentage chosen for this
year is double the historical experience and that there is no evidence to support the need for a larger
allowance. Vague worries about the recession cannot be allowed to cause a larger expense and lower
assets.
Chan should be asked to prepare an estimate of doubtful accounts based on the same criteria as prior
years, and the allowance should be adjusted accordingly.
On the other hand, Chan, the continuing owner, may have a valid concern in this area. He has to pay
his partner for his interest in these receivables; what if they are never collected? Ch ...