FAR - Receivables 3

Question 1

An internal auditor is deriving cash flow data based on an incomplete set of facts. Bad debt expense was $2,000. Additional data for this period follows: Credit sales $100,000 Gross accounts receivable – beginning balance 5,000 Allowance for bad debts – beginning balance (500) Accounts receivable written off 1,000 Increase in net accounts receivable (after subtraction of allowance for bad debts) 30,000 How much cash was collected this period on credit sales?

Answer 1

$68,000

The beginning balance of gross accounts receivable (A/R) was $5,000 (debit). Thus, net beginning A/R was $4,500 ($5,000 – $500 credit in the allowance for bad debts). The allowance was credited for the $2,000 bad debt expense. Accordingly, the ending allowance (credit) was $1,500 ($500 – $1,000 write-off + $2,000). Given a $30,000 increase in net A/R, ending net A/R must have been $34,500 ($4,500 beginning net A/R + $30,000), with ending gross A/R of $36,000 ($34,500 + $1,500). Collections were therefore $68,000 ($5,000 beginning gross A/R – $1,000 write-off + $100,000 credit sales – $36,000 ending gross A/R).

Question 2

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?

Answer 2

$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.​

Question 3

When the allowance method of recognizing uncollectible accounts is used, the entry to record the write-off of a specific account

Answer 3

Decreases both accounts receivable and the allowance for uncollectible accounts.​

When an account receivable is written off, both accounts receivable and the allowance for uncollectible accounts are decreased. If an account previously written off is collected, the account must be reinstated by increasing both accounts receivable and the allowance. The account receivable is then decreased by the amount of cash collected.

Question 4

At the end of Year 1, Boller Co. had an ending balance in allowance for uncollectible accounts of $30,000. During Year 2, Boller wrote off $40,000 of accounts receivable. At the end of Year 2, Boller had $300,000 in accounts receivable and determined that 8% of these would be uncollectible. What amount should be reported as uncollectible accounts expense on Boller’s Year 2 income statement?

Answer 4

$34,000

The Year 2 ending balance for allowance for uncollectible accounts is $24,000 ($300,000 × 8%). The write-off of a particular bad debt has no effect on bad debt expense. It is recognized as a decrease in the balance of allowance for uncollectible accounts. Therefore, the bad debt expense in Year 2 of $34,000 can be calculated as follows:

1/1/Year 2 allowance for uncollectible accounts

$30,000

Accounts written off

(40,000)

Bad debt expense

34,000

12/31/Year 2 allowance for uncollectible accounts

$24,000

Question 5

Inge Co. determined that the net value of its accounts receivable at December 31, based on an aging of the receivables, was $325,000. Additional information is as follows:

Allowance for uncollectible accounts at 1/1

$ 30,000

Uncollectible accounts written off during the year

18,000

Uncollectible accounts recovered during the year

2,000

Accounts receivable at 12/31

350,000

For the year, what would be Inge’s uncollectible accounts expense?

Answer 5

$11,000

The allowance for uncollectible accounts before year-end adjustment is $14,000 ($30,000 beginning balance – $18,000 write-offs + $2,000 recovered). The balance should be $25,000 ($350,000 year-end A/R – $325,000 net value based on aging). Thus, the allowance account should be credited and uncollectible accounts expense debited for $11,000 ($25,000 desired balance – $14,000).

Question 6

Ward Co. estimates its uncollectible accounts expense to be 2% of credit sales. Ward’s credit sales for the current year were $1 million. During the year, Ward wrote off $18,000 of uncollectible accounts. Ward’s allowance for uncollectible accounts had a $15,000 balance on January 1. In its December 31 income statement, what amount should Ward report as uncollectible accounts expense?

Answer 6

$20,000

When bad debt expense is estimated on the basis of net credit sales, a cost (bad debt expense) is being directly associated with a revenue of the period (net credit sales). Thus, uncollectible accounts expense is $20,000 ($1,000,000 credit sales × 2%).

Question 7

Based on the industry average, Davis Corporation estimates that its bad debts should average 3% of credit sales. The balance in the allowance for uncollectible accounts at the beginning of Year 3 was $140,000. During Year 3, credit sales totaled $10,000,000, accounts of $100,000 were deemed to be uncollectible, and payment was received on a $20,000 account that had previously been written off as uncollectible. The entry to record bad debt expense at the end of Year 3 would include a credit to the allowance for uncollectible accounts of

Answer 7

$300,000

Bad debt expense is based on the income statement approach. It treats bad debt expense as a function of sales on account. Thus, it is projected to be $300,000 ($10,000,000 × 3%). The entry to record bad debt expense is

Bad debt expense (Debit)

$300,000

Allowance for doubtful accounts (Credit)

$300,000

Question 8

Which of the following is a method to generate cash from accounts receivable?

Answer 8

Assignment (Pledging) - YES

Factoring (Selling) - 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.

Question 9

Red Co. had $3 million in accounts receivable recorded on its books. Red wanted to convert the $3 million in receivables to cash in a more timely manner than waiting the 45 days for payment as indicated on its invoices. Which of the following would alter the timing of Red’s cash flows for the $3 million in receivables already recorded on its books?

Answer 9

Factor The Receivables Outstanding

Factoring transfers accounts receivable to a finance company or bank (the factor) on a nonrecourse, notification (to debtors) basis. The arrangement is an outright sale. If it meets certain criteria, it is accounted for as a sale of financial assets. The seller therefore accelerates cash inflows in exchange for the factor’s fee.

Question 10

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?

Answer 10

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.

Question 11

Gar Co. factored its receivables without recourse with Ross Bank. Gar received cash as a result of this transaction, which is best described as a

Answer 11

Sale of Gar’s accounts receivable to Ross, with the risk of uncollectible accounts transferred to Ross.

When receivables are factored without recourse, the transaction is treated as a sale and the buyer accepts the risk of collectibility. The seller bears no responsibility for credit losses. A sale without recourse is not a loan. In a sale without recourse, the buyer assumes the risk of uncollectible accounts.

Question 12

When the accounts receivable of a company are sold outright to a company which normally buys accounts receivable of other companies without recourse, the accounts receivable have been

Answer 12

FACTORED (Sold)

One means of immediately realizing cash on accounts receivable is factoring, which is the outright sale of receivables for cash at a discount. Receivables may be sold with or without recourse. If the sale of receivables is with recourse, the buyer may obtain payment from the seller if the debtor defaults. Factoring is the discounting of receivables on a nonrecourse, notification basis.

Question 13

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?

Answer 13

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.

Question 14

On April 1, Aloe, Inc., factored $80,000 of its accounts receivable without recourse. The factor retained 10% of the accounts receivable as an allowance for sales returns and charged a 5% commission on the gross amount of the factored receivables. What amount of cash did Aloe receive from the factored receivables?

Answer 14

$68,000

Factoring is a transfer of receivables to a third party (a factor) who assumes the responsibility of collection. Factoring discounts receivables on a nonrecourse, notification basis. If a sale is without recourse, the transferee (the factor) assumes the risks and rewards of collection. The factor retained 10% of the receivables ($80,000 × 10% = $8,000) as a reserve (an allowance for returns) and charged a 5% commission on the gross receivables ($80,000 × 5% = $4,000). Accordingly, the transferor received $68,000 ($80,000 – $8,000 – $4,000).

Question 15

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?

Answer 15

$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)].

Question 16

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?

Answer 16

$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.

Question 17

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 gain (loss) on sale of equipment?

Answer 17

($30,000)

Emme Co. sold equipment with a carrying amount of $480,000 and received a note with a present value of $450,000 ($600,000 × .75). Thus, Emme should report a $30,000 loss ($480,000 – $450,000).

Question 18

On January 1, the Fulmar Company sold personal property to the Austin Company. The personal property had cost Fulmar $40,000. Fulmar frequently sells similar items of property for $44,000. Austin gave Fulmar a noninterest-bearing note payable in six equal annual installments of $10,000 with the first payment due this December 31. Collection of the note is reasonably assured. A reasonable rate of interest for a note of this type is 10%. The present value of an annuity of $1 in arrears at 10% for six periods is 4.355. What amount of sales revenue from this transaction should be reported in Fulmar’s income statement for the year ended December 31?

Answer 18

$44,000

When a noninterest-bearing note is exchanged for property, the note, the sales price, and the cost of the property exchanged for the note should be recorded at the fair value of the property or at the market value of the note, whichever is more clearly determinable. Here, the $44,000 fair value of the property is clearly determinable because Fulmar frequently sells similar items for that amount. Consequently, $44,000 is the proper amount to be recorded as sales revenue from this transaction.

Question 19

On December 1, Year 4, Money Co. gave Home Co. a $200,000, 11% loan. Money paid 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 $4,310, beginning January 1, Year 5. The repayments yield an effective interest rate of 11% at a present value of $200,000 and 12.4% at a present value of $194,000. What amount of income from this loan should Money report in its Year 4 income statement?

Answer 19

$2,005

Under the effective-interest method, the effective rate of interest is applied to the net carrying amount of the receivable to determine periodic interest revenue. Thus, interest revenue from the loan for the month of December equals $2,005 [$194,000 × 12.4% × (1 ÷ 12)].

Question 20

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

Answer 20

$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