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Chapter 7: 6CA_a (page 377)

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

(1) How should Rolen determine the sales price of the machine?

(2) How should Rolen report the effects of the zero-interest-bearing note on its income statement for the year ended December 31, 2016? Why is this accounting presentation appropriate?

Short Answer

Expert verified

The sales price of the machine will be equal to the fair value of the note calculated using the discounted rate. Theincome statement of 2016 will include the interest revenue for three months of 2016 October, November, and December.

Step by step solution

01

Definition of Note Dishonored

A note is said to be dishonored when the issuing business entity or individual does not pay the due amount on maturity.

02

Determination of Sales Price of Machine and Effect of Zero Interest Bearing Bonds

(1) The sales price of the machine will be reported as the fair value of the note receivable on 30 September 2016. The fair value of the note receivable will be calculated as the discounted fair value of the two installments’ at the market interest rate of the customer.

(2) The interest revenue for 2016 will be calculated as the multiplication of carrying amount, market interest rate, and 3/2. Interest revenue for 2016 will include interest for October, November, and December. Therefore, it is multiplied by 3/12.

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Most popular questions from this chapter

When is the financial components approach to recording the transfers of receivables used? When should a transfer of receivables be recorded as a sale?

From inception of operations to December 31, 2017, Fortner Corporation provided for uncollectible accounts receivable under the allowance method. The provisions are recorded, based on analyses of customers with different risk characteristics. Bad debts written off were charged to the allowance account; recoveries of bad debts previously written off were credited to the allowance account, and no year-end adjustments to the allowance account were made. Fortner’s usual credit terms are net 30 days.

The balance in Allowance for Doubtful Accounts was \(130,000 at January 1, 2017. During 2017, credit sales totalled \)9,000,000, the provision for doubtful accounts was determined to be \(180,000, \)90,000 of bad debts were written off, and recoveries of accounts previously written off amounted to \(15,000. Fortner installed a computer system in November 2017, and aging of accounts receivable was prepared for the first time as of December 31, 2017. A summary of the aging is as follows.

Classification by month of sale

Balance in each category

Estimated % uncollectible

November-December 2017

\)1,080,000

2%

July-October

650,000

10%

January-June

420,000

25%

Prior to 1/1/17

150,000

80%

\(2,300,000

Based on the review of collectibility of the account balances in the “prior to 1/1/17” aging category, additional receivables totaling \)60,000 were written off as of December 31, 2017. The 80% uncollectible estimate applies to the remaining \(90,000 in the category. Effective with the year ended December 31, 2017, Fortner adopted a different method for estimating the allowance for doubtful accounts at the amount indicated by the year-end aging analysis of accounts receivable.

Instructions

(a) Prepare a schedule analyzing the changes in Allowance for Doubtful Accounts for the year ended December 31, 2017. Show supporting computations in good form. (Hint: In computing the 12/31/17 allowance, subtract the \)60,000 write-off.)

(b) Prepare the journal entry for the year-end adjustment to Allowance for Doubtful Accounts balance as of December 31, 2017.

(Notes Receivable with Realistic Interest Rate) On October 1, 2017, Arden Farm Equipment Company sold a pecan-harvesting machine to Valco Brothers Farm, Inc. In lieu of a cash payment Valco Brothers Farm gave Arden a 2-year, $120,000, 8% note (a realistic rate of interest for a note of this type). The note required interest to be paid annually on October 1. Arden’s financial statements are prepared on a calendar-year basis.

Instructions

Assuming Valco Brothers Farm fulfills all the terms of the note, prepare the necessary journal entries for Arden Farm Equipment Company for the entire term of the note.

Wood Incorporated factored $150,000 of accounts receivable with Engram Factors Inc. on a without-recourse basis. Engram assesses a 2% finance charge of the amount of accounts receivable and retains an amount equal to 6% of accounts receivable for possible adjustments. Prepare the journal entry for Wood Incorporated and Engram Factors to record the factoring of the accounts receivable to Engram.

(Bad-Debt Reporting) Marvin Company is a subsidiary of Hughes Corp. The controller believes that the yearly allowance for doubtful accounts for Marvin should be 8% of gross accounts receivable. Given the recession and the high interest rate environment, the president, nervous that the parent company might expect the subsidiary to sustain its 10% growth rate, suggests that the controller increase the allowance for doubtful accounts to 9%. The president thinks that the lower net income, which reflects a 6% growth rate, will be a more sustainable rate for Marvin Company.

Instructions

(a) In a recessionary environment with tight credit and high interest rates:

(1) Identify steps Marvin Company might consider to improve the accounts receivable situation.

(2) Then evaluate each step identified in terms of the risks and costs involved.

(b) Should the controller be concerned with Marvin Company’s growth rate in estimating the allowance? Explain your answer.

(c) Does the president’s request pose an ethical dilemma for the controller? Give your reasons.
See all solutions

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