ACCA Audit and Assurance (F8) Practice Exam

When reviewing an allowance for uncollectable accounts, what aspect is crucial to assess?

1. The relationship with customers

2. The economic conditions affecting sales

3. Comparison with the previous year’s allowance

4. The percentage of sales attributed to bad debts

The correct answer is: Comparison with the previous year’s allowance

When reviewing an allowance for uncollectable accounts, assessing the comparison with the previous year’s allowance is crucial because it provides essential insights into the trends and changes in the company’s credit risk and collection practices. A significant increase or decrease in the allowance compared to the prior year can indicate shifts in customer payment behavior, changes in the overall financial health of the customer base, or alterations in credit policies. Additionally, this comparison helps auditors evaluate whether the allowance is reasonable and reflects the economic environment or changes in the business's operational circumstances. If the allowance has changed significantly without a corresponding justification, it warrants further investigation to ascertain whether there are underlying issues affecting accounts receivable. While other aspects, such as customer relationships, economic conditions, and percentages of sales attributed to bad debts, are relevant, they serve as contextual factors rather than the primary baseline for assessing the appropriateness of the allowance. The direct comparison with past allowances provides a clear and quantifiable way to gauge the current financial state related to potential uncollectable accounts.