Mr Johan have reviewed the draft account for 2020 and noticed that the company was in financial difficulties at the beginning of the year. Therefore, the company used its account receivables as a means of obtaining cash to continue its operations. The following is information related to selected activities for the month of January until March 2020.

15 Jan       The clients Terbaik Bhd forwarded a notice to Lampu Terang Bhd asking for longer credit period. The sales amounting RM290,000 is for previous month sales. Lampu Terang Bhd agreed to extend the credit period and convert the remaining balance of account receivable to 10%, 120-day Note Receivable.

1 Feb        Lampu Terang Bhd factored with recourse RM150,000 of account receivable for a cash proceed of RM140,000 to the Adawiyah Bank Berhad. Adawiyah Bank Berhad withheld 8% of account receivable as protection against sales return and allowance. The difference between factored account receivable and cash proceed is considered as a finance charge.

29 Feb      Adawiyah Bank Berhad manage to collect RM136,000 of the factored account receivable, which include sales return and allowance of RM5,500.  The remaining balance of account receivable is uncollectible. Settlement of factored accounts receivable was done on this date.

1 March    Lampu Terang Bhd assigned RM90,000 of its account receivable as collateral on an RM70,000, 12% loan from Adawiyah Bank Berhad. A commission of 6% on the face amount of loan was charged.

30 March  Collect RM74,000 of account receivable assigned and remitted it to Adawiyah Bank Berhad.

Mr Johan retraced the recording of the above transactions and he finds out that the related transactions are properly recorded. Mr. Johan also performed an extensive review on the “notes to account”. After reviewed the notes to accounts for Trade and Other Receivables, Mr Johan noticed that the allowance for bad debt expenses for 2020 remained the same as in previous years. It provides clues to possible errors in recording. For the past few years, 2% of account receivables are estimated to be uncollectible and the company uses the percentage of receivables method to estimate the bad debt expense. The following is the notes to the accounts for trade and other receivables.

                        Trade and Other Receivables

2020

2019

RM

RM

Trade receivables

1,650,000

1,400,000

Less: allowance for bad debt expenses

28,000

28,000

1,622,000

1,372,000

Other receivables, deposits and prepayment

88,440

111,386

Total

1,710,440

1,483,386

Explain the theoretical justification of the allowance method as contrasted with the direct write-off method of accounting for bad debts that been practiced by Lampu Terang Bhd.