Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 7: 5CA_b (page 377)

Corrs Wholesalers Co. sells industrial equipment for a standard 3-year note receivable. Revenue is recognized at time of sale. Each note is secured by a lien on the equipment and has a face amount equal to the equipment’s list price. Each note’s stated interest rate is below the customer’s market rate at date of sale. All notes are to be collected in three equal annual installments beginning one year after sale. Some of the notes are subsequently sold to a bank with recourse, some are subsequently sold without recourse, and some are retained by Corrs. At year end, Corrs evaluates all outstanding notes receivable and provides for estimated losses arising from defaults.

Instructions

How should Corrs account for the sale, without recourse, of a February 1, 2017, note receivable sold on May 1, 2017? Why is it appropriate to account for it in this way?

Short Answer

Expert verified

Carrying value must be added with the effective interest revenue, and the business entity must recognize gain or loss on the sale of receivables.

Step by step solution

01

Definition of Face Value

The value stated on the financial instrument or financial security is known as face value. It might differ from the value at which the instrument or security is issued.

02

Accounting for Sale Without Resources

The carrying value of the note receivable must be increased by adding the amount of effective interest revenue for the period starting from 1 February 2017 to 1 May 2017. On the sale of receivables without resources, the business entity must increase the cash amount by eliminating the carrying value and recognizing gain or loss equal to the difference between the carrying value and the amount received.

This reporting is appropriate because the note receivable is initially reported at its carrying value. When sold without resources, the business entity must report for gain or loss.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

On December 31, 2017, Firth Company borrowed \(62,092 from Paris Bank, signing a 5-year, \)100,000 zero-interest-rate note. The note was issued to yield 10% interest. Unfortunately, during 2019, Firth began to experience financial difficulty. As a result, at December 31, 2019, Paris Bank determined that it was probable that it would collect only $75,000 at maturity. The market rate of interest on loans of this nature is now 11%.

Instructions

(a) Prepare the entry (if any) to record the impairment of the loan on December 31, 2019, by Paris Bank.

(b) Prepare the entry on March 31, 2020, if Paris learns that Firth will be able to repay the loan under the original terms.

(Expected Cash Flows) On January 1, 2017, Botosan Company issued a \(1,200,000, 5-year, zero-interest bearing note to National Organization Bank. The note was issued to yield 8% annual interest. Unfortunately, during 2018 Botosan fell into financial trouble due to increased competition. After reviewing all available evidence on December 31, 2018, National Organization Bank decided that the loan was impaired. Botosan will probably pay back only \)800,000 of the principal at maturity.

Instructions

(a) Prepare journal entries for both Botosan Company and National Organization Bank to record the issuance of the note on January 1, 2017. (Round to the nearest $10.)

(b) Assuming that both Botosan Company and National Organization Bank use the effective-interest method to amortize the discount, prepare the amortization schedule for the note.

(c) Under what circumstances can National Organization Bank consider Botosan’s note to be impaired?

(d) Compute the loss National Organization Bank will suffer from Botosan’s financial distress on December 31, 2018. What journal entries should be made to record this loss?

(Accounting for Zero-Interest-Bearing Note) Soon after beginning the year-end audit work on March 10 at Engone Company, the auditor has the following conversation with the controller.

Controller: The year ended March 31st should be our most profitable in history and, as a consequence, the board of directors has just awarded the officers generous bonuses.

Auditor: I thought profits were down this year in the industry, according to your latest interim report.

Controller: Well, they were down, but 10 days ago we closed a deal that will give us a substantial increase for the year.

Auditor: Oh, what was it?

Controller: Well, you remember a few years ago our former president bought stock in Henderson Enterprises because he had those grandiose ideas about becoming a conglomerate. For 6 years we have not been able to sell this stock, which cost us \(3,000,000 and has not paid a nickel in dividends. Thursday we sold this stock to Bimini Inc. for \)4,000,000. So, we will have a gain of \(700,000 (\)1,000,000 pretax) which will increase our net income for the year to \(4,000,000, compared with last year’s \)3,800,000. As far as I know, we’ll be the only company in the industry to register an increase in net income this year. That should help the market value of the stock!

Auditor: Do you expect to receive the \(4,000,000 in cash by March 31st, your fiscal year-end?

Controller: No. Although Bimini Inc. is an excellent company, they are a little tight for cash because of their rapid growth. Consequently, they are going to give us a \)4,000,000 zero-interest-bearing note with payments of $400,000 per year for the next 10 years. The first payment is due on March 31 of next year.

Auditor: Why is the note zero-interest-bearing?

Controller: Because that’s what everybody agreed to. Since we don’t have any interest-bearing debt, the funds invested in the note do not cost us anything and besides, we were not getting any dividends on the Henderson Enterprises stock.

Instructions

Do you agree with the way the controller has accounted for the transaction? If not, how should the transaction be accounted for?

On September 30, 2016, Rolen Machinery Co. sold a machine and accepted the customer’s zero-interest-bearing note. Rolen normally makes sales on a cash basis. Since the machine was unique, its sales price was not determinable using Rolen’s normal pricing practices.

After receiving the first of two equal annual installments on September 30, 2017, Rolen immediately sold the note with recourse. On October 9, 2018, Rolen received notice that the note was dishonored, and it paid all amounts due. At all times prior to default, the note was reasonably expected to be paid in full.

Instructions

What are the effects of the sale of the note receivable with recourse on Rolen’s income statement for the year ended December 31, 2017, and its balance sheet at December 31, 2017?

(Recording Bad Debts) Duncan Company reports the following financial information before adjustments.

Debit

Credit

Accounts receivables

\(100,000

Allowance for doubtful accounts

\)2,000

Sales revenue (All on credit)

900,000

Sales return and allowance

50,000

Instructions

Prepare the journal entry to record Bad Debt Expense assuming Duncan Company estimates bad debts at (a) 5% of accounts receivable and (b) 5% of accounts receivable but Allowance for Doubtful Accounts had a $1,500 debit balance.
See all solutions

Recommended explanations on Business Studies Textbooks

Nature of Business

Read Explanation

Business Development

Read Explanation

Financial Performance

Read Explanation

Organizational Communication

Read Explanation

Managerial Economics

Read Explanation

Introduction to Business

Read Explanation
View all explanations

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free