Reference no: EM13683245

A colleague has asked you for advice. She was checking to see if a company is in compliance with its loan agreement that requires the company to maintain a return on equity of 10% or more. This year, the company reported a return on equity of 10.01%. But the company also reports a substantially lower balance in the Allowance for Doubtful Accounts than in the three prior years. Your colleague asks if the company is playing accounting games to maintain compliance. Do you think (a) the evidence is consistent with manipulation, (b) a low balance in the Allowance would actually make ROE go down, or (c) ROE is not affected by changes in the Allowance? Explain your answer. Return on equity compares net income to average stockholders' equity. Ignore taxes in your answer.