Ch6

top Ch6-Examples

Example 1: Sales discounts, sales returns and allowances


Gross sales, terms: (2/10/n20)	$ 15,000
sales returns/allowances	$ 200
70% of sales paid within discount period:		$ 10,500
discount		$ 210
net cash		$ 10,290

journal entries:
dr. accounts receivable	$ 15,000
cr. Revenue		$ 15,000
(to record credit sales)
dr. sales returns & allowances	$ 200
cr. Accounts receivable		$ 200
(to record sales returns)
dr. cash	$ 10,290
dr. Sales discounts	$ 210
cr. Accounts receivable		$ 10,500
(to record cash receipt and sales discounts)
dr. cash	$ 4,500
cr. Accounts receivable		$ 4,500
(to record cash receipt from remaining receivables)

Note: this assumes all accounts are paid

Income Statement:
Revenue	$ 15,000
less sales returns	$ (200)
less sales discounts	$ (210)	$ 14,590

or: Revenue (net)	$ 14,590

Example 2: Bad Debt Expense


total credit sales			$ 22,000
accounts receivable, 12/31			$ 9,000
allowance for uncollectible
accounts, 12/31 before adjustments:			$ 200
percent of revenue expected to be uncollectible			3%
*bad debt expense: ($22,0003%)**			$ 660

Journal entry:
dr. bad debt expense		$ 660
cr. Allowance for uncollectible accounts			$ 660

Income Statement:
Revenue	$ 22,000

Operating expenses:
bad debt expense	$ (660)

Balance Sheet:
Accounts receivable		$ 9,000
less allowance for
uncollectible accounts		$ (860)
Accounts receivable (net)		$ 8,140

	Aging of Accounts Method
Aging Schedule
Age	$ amount	percent	$ amount
		uncollectible	uncollectible
0 to 20 days	$ 5,000	2%	$ 100
20 to 40 days	$ 3,000	12%	$ 360
40 to 60 days	$ 600	20%	$ 120
60 + days	$ 400	50%	$ 200
Total	$ 9,000		$ 780

Journal entry:
dr. bad debt expense		$ 580
cr. Allowance for uncollectible accounts			$ 580

Income Statement:
Revenue	$ 22,000

Operating expenses:
bad debt expense	$ (580)

Balance Sheet:
Accounts receivable	$ 9,000
less allowance for
uncollectible accounts	$ (780)
Accounts receivable (net)	$ 8,220

to write off an account:

dr. allowance for uncollectible
accounts	$ 150
cr. Accounts receivable		$ 150

Example 3: Pledging, Assigning of Accounts Receivable
1. Pledging: X Company has accounts receivable in the amount of $ 75,000. X Company borrows $40,000 at 8% payable in six month, from First Bank and pledges receivables in he amount of $60,000 as security. Journal entries:
dr. cash	$ 40,000
cr. note payable	$ 40,000
(record loan)
No formal entry is made of the pledging of accounts receivable as security for the loan. However, this fact must be disclosed on the balance sheet (footnote)
dr. cash	$30,000
cr. accounts receivable	$30,000
(record partial collection of accounts receivable)
dr. note payable	$40,000
dr. interest expense	$ 160
cr. cash	$40,160
(record payment of principal and interest)

2. Assigning of Accounts Receivable
X Company assigns accounts receivable in the amount of $40,000 and receives $35,000 cash from First Bank. 8% interest on the outstanding loan balance.
dr. cash	$35,000
cr. note payable	$35,000
dr. accounts receivable - assigned	$40,000
cr. accounts receivable	$40,000
(to record receipt of cash and assigning of accounts)
dr. cash	$10,000
cr. accounts receivable	$10,000
dr. note payable	$ 10,000
dr.interest expense	$ 233
cr. cash	$10,233
(to record collection of 1st month accounts receivable and payment to bank, including 1 month interest (35,000*.08/12)
dr. cash	$28,000
cr. accounts receivable	$28,000
dr. note payable	$ 25,000
dr.interest expense	$ 167
cr. cash	$10,167
(to record collection of 2nd month accounts receivable and payment to bank, including 1 month interest (25,000*.08/12)
dr. accounts receivable	$ 2,000
cr. accounts receivable - assigned	$ 2,000
(to reverse assignment of remaining acounts receivable)

Example 4: Factoring of Accounts Receivable
X Company has accounts receivable in the amount of $ 75,000. X Company factors (sells) the receivable without recourse to First Bank and receives $ 68,250 in cash The amount of cash received is determined as follows:
factoring expense	$ 4,500
provision for sales discounts	$ 1,500
provision for sales returns	$ 750
Note: the provisions for sales discounts and returns are contingent. These amounts are withheld by the factor and X company may receive some of these amounts, if actual returns and discounts are less than estimated.
Journal entries:
dr. cash	$ 68,250
dr. factoring expense	$ 4,500
dr. due from factor	$ 2,250
cr. accounts receivable	$75,000
(to record factoring of accounts receivable without recourse)

X Company is notified by First Bank that actual sales returns amounted to $500 and sales discounts were taken in the amount of $ 1,200. X Company receives a check for $550 from First Bank
Journal entries:
dr. cash	$ 550
dr. sales discounts	$1,200
dr sales returns.	$ 500
cr. due from factor	$2,250
(to record sales returns and discounts and receipt of cash)

Note that this was a factoring without recourse (risk was transferred) If the accounts had been factored with recourse the initial set of journal entries would have differed: instead of a credit to accounts receivable. it would have required a credit to accounts receivable - factored with recourse (a contingent liability) In other words, the same treatment as when accounts are assigned, except for slightly different (factored instead of assigned) terminology)

Example 5. Interest bearing notes (short or long term)

These type of notes do not present any accounting issues. Just remember to accrue interest income at the appropriate time

Face value	$100,000
interest rate	10%
issue date	11/01/1998
maturity date	05/01/1999
Journal entries
issuance:			Date
dr. notes receivable	$100,000		11/01/1998
cr. Sales revenue		$100,000
dr. interest receivable	$1,667		12/31/1998
cr. interest income		$1,667
dr. cash	$105,000		05/01/1999
cr. Interest receivable		$1,667
cr. interest income		$3,333
cr. Notes receivable		$100,000

Example 6. Non interest bearing note, less than one year to maturity:


Needed: appropriate discount rate. Should be the customer's borrowing rate (if known). Otherwise use the seller's required rate of return

Face value	$100,000
interest rate	0%
issue date	11/01/1998
maturity date	05/01/1999
Assume that 10% is the appropriate disocunt rate

1. Determine correct amount of revenue:			100,000 / 1.05 =
		Revenue:	$95,238

Journal entries:
dr. note receivable		$100,000		11/01/1998
cr. Revenue			$95,238
cr. Discount on note receivable			$4,762

dr. discount on note receivable		1587.30159		12/31/1998
cr. Interest income			1587.30159

Note that straight line is used to determine the amount of interest income as of 12/31/98

Balance Sheet as of 12/31/1998

Note receivable		$100,000
less discount		-$3,175	$96,825

dr. cash		$100,000		05/01/1999
dr. discount		$3,175
cr. Note receivable			$100,000
cr. Interest income			$3,175

Example 7: Non interest bearing note, more than one year to maturity:

needed: appropriate discount rate. Should be the customer's borrowing rate (if known). Otherwise use the seller's required rate of return
Face value	$100,000
interest rate	0%
issue date	01/01/1998
maturity date	01/01/2003

1. Determine correct amount of revenue:			100,000 * PV(10%,5)		0.620921
		Revenue:	$62,092
Journal entries:
dr. note receivable		$100,000		01/01/1998
cr. Revenue			$62,092
cr. Discount on note receivable			$37,908

dr. discount on note receivable		$6,209		12/31/1998
cr. Interest income			6209.21

Note that the "effective method" is used to determine the amount of interest income
See the table below on how to determine the correct amount of interest income each period:
Balance Sheet:
Note receivable		$100,000
less discount		-$31,699	$68,301

dr. cash		$100,000		01/01/2003
dr. discount		$9,091
cr. Note receivable			$100,000
cr. Interest income			$9,091
(to record payment at maturity)

	Interest amortization table
Carrying value	interest	interest	cash	increase in
	rate	income	receipt	carrying value

$62,092	10%	$6,209	$0	$6,209
$68,301	10%	$6,830	$0	$6,830
$75,131	10%	$7,513	$0	$7,513
$82,645	10%	$8,264	$0	$8,264
$90,909	10%	$9,091	$100,000	-$90,909
$0

Example 8. Non-interest bearing note, more than one year, periodic payments (annual payments)
Face value of note	$100,000
annual payments	20000
discounted at 10%:			Pva(5.10%)	3.7908
Revenue	$75,816
issue date	01/01/1998
maturity date	12/31/2002	payments are due annually on 12/31

	Interest amortization table

Carrying value	interest	interest	cash	decrease in
	rate	income	receipt	carrying value

$75,816	10%	$7,582	$20,000	-$12,418
$63,398	10%	$6,340	$20,000	-$13,660
$49,737	10%	$4,974	$20,000	-$15,026
$34,711	10%	$3,471	$20,000	-$16,529
$18,182	10%	$1,818	$20,000	-$18,182
$0		$24,184	$100,000	-$75,816

dr. note receivable	100000.4262			01/01/1998
cr. Revenue		$75,816
cr. Discount		$24,184

dr. discount	$7,582			12/31/1998
cr. Interest income		$7,582
dr. cash	$20,000
cr. Note receivable		$20,000

Balance Sheet as of 12/31/98:

Note receivable	$80,000
less discount	-$16,603	$63,398

dr. cash	20000
cr. Note receivable		20000
dr. discount	$6,340			12/31/1999
cr. Interest income		$6,340

Balance Sheet as of 12/31/99

Note receivable	$60,000
less discount	-$10,263	$49,737

Example 9: below market interest rate, 1 year (interest to be paid at maturity) Needed: appropriate discount rate. Should be the customer's borrowing rate (if known) Otherwise use the seller's required rate of return. Assume 10% is appropriate discount rate
Face value	$100,000
interest rate	2%
issue date	01/01/1998
maturity date	01/01/1999

1. Maturity value: (100,000*1.02)		$ 102,000

1. Determine correct amount of revenue:			102,000 * PV(10%,1)		0.90909
		Revenue:	$90,909

dr. note receivable		$100,000		01/01/1998
cr. Revenue			$90,909
cr. Discount on note receivable			$9,091

dr. discount on note receivable		$9,091		12/31/1998
dr. interest receivable		$2,000
cr. Interest income			9091

dr. cash		$ 102,000		01/01/1999
cr. Note receivable			$100,000
cr. Interest receivable			$2,000

Example 10: Notes Receivable, below market interest rate, interest paid annually

Face value	$100,000	PV(10%,5)	0.62092	62092
interest rate	2%
annual int. paymnt	$2,000	PVa(10%,5)	3.79079	7581.58
issue date	01/01/1998
maturity date	01/01/2003

Present value of note + interest payments				69673.58

dr. note receivable (net)	$100,000		01/01/1998
cr. Revenue		69673.58
cr. Discount on N/R		$30,326

dr. interest receivable	$2,000		12/31/1998
dr. discount	$4,967
cr. Interest income		$6,967
dr. cash	$2,000		01/01/1999
cr. Interest receivable		$2,000

Note that the "effective method" is used to determine the amount of interest income
See the table below on how to determine the correct amount of interest income each period:
	Interest amortization table

Carrying value	interest	interest	cash	increase in
	rate	income	receipt	carrying value

$69,674	10%	$6,967	$2,000	$4,967
$74,641	10%	$7,464	$2,000	$5,464
$80,105	10%	$8,011	$2,000	$6,011
$86,116	10%	$8,612	$2,000	$6,612
$92,727	10%	$9,273	$102,000	-$92,727
$0

Example 11: Notes receivable discounted with and without recourse

Step 1	Face value	$ 7,872
Step 2	interest rate	9%
Step 3	days	180
Step 4	interest to maturity	$ 354		*123/360*
Step 5	maturity value	$ 8,226		1+5
Step 6	discount rate	15%
Step 7	days to maturity	120
Step 8	discount	$ 617		*567/360*
Step 9	proceeds	$ 7,609.27		5-8
Step 10	days interest earned	60		3-7
Step 11	interest earned to date	$ 118		*1210/360*
Step 12	bookvalue of note	$ 7,990		1+11
Step 13	interst expense	$ (175)		9-12

Journal entries (a) without recourse

	dr. note receivable	$ 7,872
	cr. revenue		$ 7,872

	dr. interest receivable	$ 118
	cr. interest income		$118

	dr. cash	$ 7,815
	dr. interst expense	$ 175
	cr. interest receivable		$118
	cr. note receivable		$ 7,872

Journal entries (b) with recourse

	dr. note receivable	$ 7,872
	cr. revenue		$ 7,872

	dr. interest receivable	$ 118
	cr. interest income		$118

	dr. cash	$ 7,815
	dr. interst expense	$ 175
	cr. interest receivable		$118
	cr. note receivable discounted		$ 7,872
	after notification that note has been paid:
	dr. notes receivable discounted	$ 7,872
	cr. note receivable		$ 7,872

	assuming note was not paid, bank demands full payment and charges $50 fee

	dr. notes receivable discounted	$ 7,872
	cr. note receivable		$ 7,872
	dr. notes receivable dishonored		$ 8,276
	cr. Cash			$ 8,276

Note that a. The amount paid to the bank consists of the maturity value plus the fee charged.
b. The entire amount will be recorded in an account called "notes receivable dishonored" and
the company will attempt to collect this amount. Only if evidence exists that collection will definitelynot occur (I.e., bankruptcy judgement) will the debit be made to a loss account or to the allowance for uncollectibles.

Definitions
Account receivable	A revolving credit arrangement: Once an account is established, customers can purchase "on account" without further formality, as long as invoices are paid promptly
Net realizable value: Account receivable	Accounts receivable less allowance for uncollectible accounts
Sales discounts	A euphemism for interest. "Gross" invoice prices include interest. If customers pay bills quickly (acording to the sales terms) this interest does not have to be paid. The customers pays the "net" amount or receives a discount
Sales Terms	see sales discounts: (interest/days/net/days) e.g., (3/10,n30)
Sales Returns	merchandise is returned for refund.
Sales Allowances	adjustment of sales price, no return of merchandise
Assigning	Specific accounts receivables are used as security for a loan. As the accounts are collected, the cash is transmitted to the financing institution (plus interest on the outstanding balance) Assigned accounts are identified on the balance sheet
Pledging	Accounts receivable in general are used as security for a loan. No specific accounts. No special identification on the balance sheet, but footnote disclosure is required. Payment on the loan is independent of receivable collection.
Factoring	Selling of accounts receivable. Receivables are sold without recourse (all risks are transferred to the financing institution) or with recourse (risk remains with the selling company. This is equivalent to borrowing)
Note receivable	Formal borrowing arrangement with specified payment terms and interest. Interest may be explicitly stated or may be included in the face value (amount to be paid at maturity) . Sometimes the explicit interest rate is less than the normal market rate. In that case additional interest is "buried" in the face value
Discounting (Notes A)	Notes without (or with below market) interest rates must be "discounted". This refers to calculating the amount of interest that is included in the face value of the note. If the maturity date of the note (date when the note must be paid) is more than one year away, a present value calculation is required.
Discounting (Notes B)	Term used for selling of notes. The reason sale of a note is called "discounting" is because it involves an interest calculation to determine how much cash will actually be received. This discounted considers (a) the amount of interest that will be paid by the customer and (b) the amount of interest the financing institution wants to earn.
Recourse	Refers to the fact that sometimes accounts or notes are sold on a contingent basis. This means that the seller is not released from liability until the customer has actually paid the financing institution. In other words, these types of sales are really a form of borrowing.

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