6.1 Flashcards
Bee Co. uses the direct write-off method to account for uncollectible accounts receivable. During an accounting period, Bee’s cash collections from customers equal sales adjusted for the addition or deduction of the following amounts:
Accounts written-off:
Increase in AR balance:
Deduction
Deduction
The direct write-off method debits bad debt expense and credits accounts receivable when an account is written off. Sales are recorded by a debit to accounts receivable or cash and a credit to sales. Accordingly, in the reconciliation of sales to cash collections, an increase in accounts receivable reflects sales without collections. Write-offs of accounts receivable likewise represent sales without collections. Consequently, the increase in accounts receivable and the accounts written off are deductions in reconciling sales to cash collections.
On July 1, Lee Co. sold goods in exchange for a $200,000 8-month noninterest-bearing note receivable. At the time of the sale, the note’s market rate of interest was 12%. What amount did Lee receive when the note was discounted at a bank at 10% on September 1?
$190,000.
The maturity amount of a noninterest-bearing note receivable is its face amount. The discount fee is $10,000 [$200,000 maturity amount × 10% × (6 months ÷ 12)]. Thus, the proceeds equal $190,000 ($200,000 – $10,000).
Milton Co. pledged some of its accounts receivable to Good Neighbor Financing Corporation in return for a loan. Which of the following statements is correct?
Milton will retain control of the receivables.
A pledge (a general assignment) is the use of receivables as collateral (security) for a loan. The borrower agrees to use collections of receivables to repay the loan. Upon default, the lender can sell the receivables to recover the loan proceeds. Because a pledge is a relatively informal arrangement, it is not reflected in the accounts. A transfer of financial assets is a sale only when the transferor relinquishes control. If the transfer (e.g., a pledge) of accounts receivable is not a sale, the transaction is a secured borrowing. The transferor becomes a debtor, and the transferee, a creditor in possession of collateral. However, absent default, the collateral remains an asset of the transferor.
Which of the following is a method to generate cash from accounts receivable?
Assignment:
Factoring:
Yes
Yes
Methods of generating cash from accounts receivable include both assignment and factoring. Assignment occurs when specifically named accounts receivable are pledged as collateral for a loan. The accounts receivable remain those of the assignor. However, when cash is collected from these accounts receivable, the cash must be remitted to the assignee. Accounts receivable are factored when they are sold outright to a third party. This sale may be with or without recourse.
Rand, Inc., accepted from a customer a $40,000, 90-day, 12% interest-bearing note dated August 31. On September 30, Rand discounted the note at the Apex State Bank at 15%. However, the proceeds were not received until October 1. In Rand’s September 30 balance sheet, the amount receivable from the bank, based on a 360-day year, includes accrued interest revenue of
$170.
As determined below, the interest received by Rand if it had held the 90-day note to maturity would have been $1,200. The discount fee charged on a note with a maturity amount of $41,200 ($40,000 face amount + $1,200 interest) discounted at 15% for 60 days is $1,030. The difference of $170 ($1,200 interest – $1,030 discount fee) should be reflected as accrued interest revenue at the balance sheet date because the cash proceeds were not received until the next period.
$40,000 × 12% × (90 ÷ 360) = $1,200 interest
$41,200 × 15% × (60 ÷ 360) = (1,030) discount fee
Accrued interest revenue $170
The following information has been compiled by Able Manufacturing Company:
- Sale of company products for the period to customers with net 30-day terms amounting to $150,000.
- Sale of company products for the period to a customer, supported by a note for $25,000, with special terms of net 180 days.
- Balance of trade receivables at the end of the last period was $300,000.
- Collections of open trade receivables during the period was $200,000.
- Rental income for the period, both earned and accrued but not yet collected, from the Able Employees’ Credit Union for use of company facilities was $2,000.
The open trade receivables balance to be shown on the statement of financial position for the period is
$250,000.
The open trade receivables balance is calculated as follows:
Previous ending balance: $300,000
Add: Sales to customers (terms net 30): 150,000
Minus: Collections during period: (200,000)
Open trade receivables reported: $250,000
Marr Co. had the following sales and accounts receivable balances, prior to any adjustments at year end:
Credit sales: $10,000,000
Accounts receivable: 3,000,000
Allowance for uncollectible accounts: 50,000
Marr uses 3% of accounts receivable to determine its allowance for uncollectible accounts at year end. By what amount should Marr adjust its allowance for uncollectible accounts at year end?
$40,000.
The entity uses the percentage of accounts receivable method to estimate the allowance. The year-end balance should be $90,000 ($3,000,000 A/R × 3%). Hence, the year-end adjustment is $40,000 ($90,000 – $50,000) unadjusted balance.
Under the allowance method of recognizing uncollectible accounts, the entry to write-off an uncollectible account
Has no effect on net income.
The entry to record bad debt expense under the allowance method is to debit bad debt expense and credit the allowance account. When a specific account is then written off, the allowance is debited and accounts receivable credited. Net income is affected when bad debt expense is recognized, not at the time of the write-off. Because accounts receivable and the allowance account are decreased by the same amount, a write-off of an account also has no effect on the net amount of accounts receivable.
Mill Co.’s allowance for uncollectible accounts was $100,000 at the end of Year 2 and $90,000 at the end of Year 1. For the year ended December 31, Year 2, Mill reported bad debt expense of $16,000 in its income statement. What amount did Mill debit to the appropriate account in Year 2 to write off actual bad debts?
$6,000.
When uncollectible accounts are written off, a debit is made to the allowance and a credit to accounts receivable. The beginning balance in the allowance account is $90,000, the ending balance is $100,000, and the bad debt expense is $16,000. Because write-offs equal the beginning balance, plus the bad debt expense, minus the ending balance, $6,000 of accounts must have been written off.
Johnson Company uses the allowance method to account for uncollectible accounts receivable. After recording the estimate of uncollectible accounts expense for the current year, Johnson decided to write off in the current year the $10,000 account of a customer who had filed for bankruptcy. What effect does this write-off have on the company’s current net income and total current assets, respectively?
Net Income:
Total Current Assets:
No effect
No effect
Johnson uses the allowance method. Thus, when a specific amount is written off, the journal entry is
Allowance for doubtful accounts $10,000
Accounts receivable $10,000
The write-off of a bad debt has no effect on expenses, net income, and total current assets.
On December 1, Year 4, Tigg Mortgage Co. gave Pod Corp. a $200,000, 12% loan. Pod received proceeds of $194,000 after the deduction of a $6,000 nonrefundable loan origination fee. Principal and interest are due in 60 monthly installments of $4,450, beginning January 1, Year 5. The repayments yield an effective interest rate of 12% at a present value of $200,000 and 13.4% at a present value of $194,000. What amount of accrued interest receivable should Tigg include in its December 31, Year 4, balance sheet?
$2,000.
Accrued interest receivable is always equal to the face amount times the nominal rate for the period of the accrual. Thus, the accrued interest receivable is $2,000 [$200,000 × 12% × (1 ÷ 12)].
On March 31, Vale Co. had an unadjusted credit balance of $1,000 in its allowance for uncollectible accounts. An analysis of Vale’s trade accounts receivable at that date revealed the following:
0-30 days
$60,000
5%
31-60 days
4,000
10%
Over 60 days
2,000
70%
What amount should Vale report as allowance for uncollectible accounts in its March 31 balance sheet?
$4,800.
The aging schedule determines the balance in the allowance for uncollectible accounts. Of the accounts that are no more than 30 days old, the amount uncollectible is $3,000 ($60,000 × 5%). Accounts that are 31-60 days old and over 60 days old have estimated uncollectible balances of $400 ($4,000 × 10%) and $1,400 ($2,000 × 70%), respectively. Hence, the amount recorded in the allowance for uncollectible accounts is $4,800 ($3,000 + $400 + $1,400). The $1,000 balance already in the account is disregarded because the aging schedule determines the balance that should be in the account.
The amount of cash received from the transfer of receivables with recourse is most likely to be reported as a liability under which of the following conditions?
The transferor is entitled and obligated to repurchase the receivables at a later date.
A transfer of financial assets with recourse is accounted for as a sale if the transferor surrenders control. An example of effective control is an agreement that entitles and obligates the transferor to repurchase or redeem the transferred assets prior to maturity. If the control criteria are not met, the transferor and transferee account for a transfer with recourse as a secured borrowing with a pledge of collateral.
Fact Pattern:
On January 2, Year 3, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 noninterest-bearing note due January 2, Year 6. There was no established exchange price for the equipment, and the market value of the note cannot be reasonably approximated. The prevailing rate of interest for a note of this type at January 2, Year 3, was 10%. The present value of 1 at 10% for three periods is 0.75.
In Emme’s Year 3 income statement, what amount should be reported as interest income?
$45,000.
When a noninterest-bearing note is exchanged for property, and neither the note nor the property has a clearly determinable exchange price, the present value of the note should be the basis for recording the transaction. The present value is determined by discounting all future payments using an appropriately imputed interest rate. Emme Co. will receive $600,000 cash in 3 years. Assuming that 10% is the appropriate imputed rate of interest, the present value (initial carrying amount) of the note at January 2, Year 3, was $450,000 ($600,000 × 0.75). Under the interest method, interest income for Year 3 was $45,000 ($450,000 × 10%), and the entry is to debit the discount and credit interest income for that amount.
On July 1, Year 3, Kay Corp. sold equipment to Mando Co. for $100,000. Kay accepted a 10% note receivable for the entire sales price. This note is payable in two equal installments of $50,000 plus accrued interest on December 31, Year 3, and December 31, Year 4. On July 1, Year 4, Kay discounted the note at a bank at an interest rate of 12%. Kay’s proceeds from the discounted note were
$51,700.
Following the receipt of $50,000 plus accrued interest on December 31, Year 3, the remaining balance was $50,000. Because the second installment is due 1 year after the first, the interest attributable to this balance is $5,000 ($50,000 principal × 10% × 1 year). On July 1, Year 4, the $55,000 maturity value ($50,000 note + $5,000 interest) is discounted at 12% for the remaining 6 months of the term of the note. The discount fee charged would be $3,300 [$55,000 maturity amount × 12% × (6 ÷ 12)]. The net proceeds are equal to the $55,000 maturity value minus the $3,300 discount fee, or $51,700.
$50,000 × 10% × 1 year = $5,000 interest
$55,000 × 12% × (6 ÷ 12) = $3,300 discount fee
