Chelsea Company (CC) owes KCC $82,000 for a computer system installation that was purchased in March of 2021. CC has run into financial difficulties due to dramatic decreases in the selling price of goods purchased from CC during recent years. In August of 2021, Florence King (KCC president) and Gen Williams (KCC controller) established a repayment schedule in which CC 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. (CC has continued to make small purchases from KCC on a cash basis.)

Your discussion with management indicates that CC received a going concern modification from its auditors for the year ended 8/30/21 (the audit report was dated 10/22/21). The going concern modification arose due to a question concerning whether CC can obtain new financing when needed, on June 30, 2022. However, the situation is not entirely bleak for CCs future as layoffs of 1/3 of the companys employees resulted in a situation in which CC operated at break even for the year ended 8/3021. CC has discussed filing for bankruptcy with bankruptcy legal counsel and at this point believes it is unnecessary. But, if it becomes necessary, counsel suggests that creditors shouldnt 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 both the CC audited annual statements (8/30/21) and the interim statements (11/30/21) indicates that if bankruptcy is declared, a recovery of 50-60 cents on the dollar (with no amount more probable than another in that range) is likely. Yet, its difficult to know what the situation will be in the future.

The sales agreement for the computer system allows KCC to repossess the equipment at any time prior to bankruptcy. But, because the equipment is used and specific to CCs applications, management believes that the equipment could be sold for a (net) of between $20,000 and $30,000. Also, management points out that such an action would not be considered positively by either CC or a number of other companies that KCC is attempting to attract as clients. Accordingly, KCC has resisted this option and does not intend to pursue it at this time.

Your analysis of the interim statements (unaudited) reveals that CC operated at a slight profit during the first quarter and that goods purchased from CC prices have increased by approximately 15 percent. However, experts disagree widely as to future CC prices as there is some concern that a significant increase in CCs goods from India may enter the US market. Finally, CCs 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 CC 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?