10. Receivables

Question 1

A company sells equipment for a two-year, $10,000 non-interest bearing note. How do you impute an interest rate for the note when fair value of the equipment sold and fair value of the note are not available?

Answer 1

1. Debit “Notes Receivable” for the face value of the note ($10,000).
2. Credit “Equipment” for the carrying value of the equipment sold (e.g. $6,000)
3. Calculate present value of $10,000 for two years at a reasonable rate (given: 10%) by multiplying the note’s face value by the PV factor (given: 0.8265). $10,000 x 0.8265 = $8,265.
4. Credit “Discount on Note Receivable” for the difference between face value and PV: $10,000 - $8,265 = $1,735
5. Credit “Gain on Sale” for $10,000 (face value) - $1,735 (discount) - $6,000 (carrying value of equipment) = $2,265.

Question 2

How do you calculate interest amortization using the effective interest rate method?

Answer 2

Carrying Value x Effective Interest Rate = Interest Income - Cash Payment (face value x stated interest rate x time) = Amortization of Discount/Premium

Example: Company A has a $10,000, two-year non-interest-bearing note receivable. Discounting the note at a reasonable rate of 10% over two years, the present value of the note is $8,265, which is the carrying value. How much of the discount (i.e. interest) is amortized in year one?

Carrying value ($8,265) x Effective Interest Rate (10%) = $826.50

There is no cash payment in year one because the entire payment is due in year two. Therefore, amortized discount in year one = $826.50.

Question 3

How do you discount a note receivable?

Answer 3

To discount is to sell a note receivable for cash before the end of its term. The discount rate is multiplied by the face value of the note and prorated for the time to maturity.

Example: On July 1, Company X sells goods in exchange for a $200,000 non-interest-bearing, eight-month note receivable. On Sep. 1, Company X discounts the note at 10%. Since there are six months to maturity, the discount on the note is (6/12 x 10%) x $200,000 = $10,000. Therefore, the company receives $200,000 - $10,000 = $190,000.

Question 4

When factoring receivables, what does it mean when the factor “retains” some of the sales as an allowance for returns?

Answer 4

The factor (i.e. the buyer of receivables) may hold back some of the money it pays to the seller to cover the estimated cost of returns from customers. This reduces the total proceeds paid to the seller for the receivables.

Example: Company A factors $900,000 of its receivables without recourse, and the factor retains 8% of the receivables as an allowance for returns. In addition, the factor charges a 4% commission on the gross receivables. Therefore the factor pays a total of 900,000 - 72,000 (8% x 900,000) - 36,000 = 792,000.