The following financial information represents Hadley Company’s first year of operations, 1996. (Ignoring potential bad debts can lead to Income Statement Balance Sheet serious overstatements) Sales $200,000 Cash $ 5,000 Cost of goods sold 102,000 Accounts receivable 85,000 Gross profit $ 98,000 Other assets 40,000 Expenses 65,000 Total assets $130,000 Net income $ 33,000 Current liabilities Long-term notes payable Stockholders’ equity Total liabilities and stockholders’ equity $ 13,000 80,000 37,000 $130,000 After reading Hadley’s financial statements, you conclude that the company had a very suc¬ cessful first year of operations. However, after further examination you note that the sales fig¬ ure on the income statement was not adjusted for a bad debt charge. You also realize that a large percentage of Hadley’s sales were to three customers, one of which, Litzenberger Supply, is in very questionable financial health, although still in business. Litzenberger owes Hadley $50,000 as of the end of 1996. REQUIRED:

a. Adjust the financial statements of Hadley Company to reflect a more conservative report¬ ing with respect to bad debts. That is, establish a provision for the uncollectibility of Litzenberger’s account. Recompute net income. How does this adjustment affect your assessment of Hadley’s first year of operations?

b. Why would auditors probably require that Hadley choose the more conservative report¬ ing?

c. Hadley’s chief financial officer claims that no bad debt charge should be recorded because Litzenberger is still conducting operations as of the end of 1996. How would you respond to this claim