[amp_mcq option1=”Net profit would decrease” option2=”Net profit would increase” option3=”Gross profit would overstate” option4=”Gross profit would understate” correct=”option1″]
The correct answer is: A. Net profit would decrease.
Bad debts are uncollectible accounts receivable. When a firm does not record bad debts, it is essentially inflating its accounts receivable balance. This will cause net income to be overstated, as net income is calculated by taking revenue minus expenses. Since accounts receivable is an asset, inflating it will increase revenue and therefore net income. However, when the firm eventually realizes that the accounts receivable are uncollectible, it will have to write them off as an expense. This will decrease net income.
Gross profit is calculated by taking revenue minus cost of goods sold. Since bad debts do not affect cost of goods sold, they will not affect gross profit.
Here is a more detailed explanation of each option:
- Option A: Net profit would decrease. This is the correct answer, as explained above.
- Option B: Net profit would increase. This is incorrect, as net profit would decrease.
- Option C: Gross profit would overstate. This is incorrect, as gross profit is not affected by bad debts.
- Option D: Gross profit would understate. This is incorrect, as gross profit is not affected by bad debts.