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Chapter 7: 2CA (page 376)

Kimmel Company uses the net method of accounting for sales discounts. Kimmel also offers trade discounts to various groups of buyers.

On August 1, 2017, Kimmel sold some accounts receivable on a without recourse basis. Kimmel incurred a finance charge.

Kimmel also has some notes receivable bearing an appropriate rate of interest. The principal and total interest are due at maturity. The notes were received on October 1, 2017, and mature on September 30, 2019. Kimmel鈥檚 operating cycle is less than one year.

Instructions

(a) (1) Using the net method, how should Kimmel account for the sales discounts at the date of sale? What is the rationale for the amount recorded as sales under the net method?

(2) Using the net method, what is the effect on Kimmel鈥檚 sales revenues and net income when customers do not take the sales discounts?

(b) What is the effect of trade discounts on sales revenues and accounts receivable? Why?

(c) How should Kimmel account for the accounts receivable factor on August 1, 2017? Why?

(d) How should Kimmel account for the note receivable and the related interest on December 31, 2017? Why?

Short Answer

Expert verified

1. Net method reports sales at its net realizable value.

2.Trade discount is not reported in books of accounts.

3. Factoring will reduce the accounts receivable and increase the balance of cash and loss.

4. Note and interest receivable will be considered as non-current assets.

Step by step solution

01

Definition of Sales Discount

Sales discount can be defined as the reduction in the price offered by the seller of the product. It is provided as a specific percentage of the sales price. Such a discount is reported as an expense by the seller.

02

Effect and Accounting of Net Method of Sales Discount

(1) Under the net method, Kimmel must account for sales discount by reporting the accounts receivables and sales revenue on net realizable value, i.e., sales price less discount.

Under the net method, the sales must be recorded at their cash equivalent value or transaction price.

03

Effect of Trade Discount on Sales Revenue and Accounts Receivables

Trade discount is not reported in the accounts and is also not reflected in the financial statement of the business entity. The sales revenue and the accounts receivables are reported after deducting the trade discount.

04

Reporting Factor of Accounts Receivables

The business entity must reduce the accounts receivables balance by the amount of receivables factored. It is done by crediting accounts receivables, debiting cash, and debiting loss. Loss is calculated by deducting the cash received from the carrying amount of accounts receivable.

05

Reporting Note Receivable and Related Interest

The business entity must report the Note receivable and Interest receivable as a non-current asset on the balance sheet because the company鈥檚 operating cycle is less than one year, and the note will get mature after two years.

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Most popular questions from this chapter

Francis Equipment Co. closes its books regularly on December 31, but at the end of 2017 it held its cash book open so that a more favorable balance sheet could be prepared for credit purposes. Cash receipts and disbursements for the first 10 days of January were recorded as December transactions. The information is given below.

1. January cash receipts recorded in the December cash book totaled \(45,640, of which \)28,000 represents cash sales, and \(17,640 represents collections on account for which cash discounts of \)360 were given.

2. January cash disbursements recorded in the December check register liquidated accounts payable of \(22,450 on which discounts of \)250 were taken.

3. The ledger has not been closed for 2017.

4. The amount shown as inventory was determined by physical count on December 31, 2017.

The company uses the periodic method of inventory.

Instructions

(a) Prepare any entries you consider necessary to correct Francis鈥檚 accounts at December 31.

(b) To what extent was Francis Equipment Co. able to show a more favorable balance sheet at December 31 by holding its cash book open? (Compute working capital and the current ratio.) Assume that the balance sheet that was prepared by the company showed the following amounts:

Debit

Credit

Cash

\(39,000

Accounts receivables

42,000

Inventory

67,00

Accounts payable

\)45,000

Other Current liabilities

14,200

On June 3, Arnold Company sold to Chester Company merchandise having a sale price of \(3,000 with terms of 2/10, n/60, f.o.b. shipping point. An invoice totaling \)90, terms n/30, was received by Chester on June 8 from John Booth Transport Service for the freight cost. On June 12, the company received a check for the balance due from Chester Company

Instructions

(a) Prepare journal entries on the Arnold Company books to record all the events noted above under each of the following bases.

(1) Sales and receivables are entered at gross selling price.

(2) Sales and receivables are entered at net of cash discounts.

(b) Prepare the journal entry under basis 2, assuming that Chester Company did not remit payment until July 29.

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鈥檚 list price. Each note鈥檚 stated interest rate is below the customer鈥檚 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

What is the appropriate valuation basis for Corrs鈥檚 notes receivable at the date it sells equipment?

Under IFRS, receivables are to be reported on the balance sheet at:

(a) amortized cost.

(b) amortized cost adjusted for estimated loss provisions.

(c) historical cost.

(d) replacement cost.

Use the information in BE7-10 for Wood. Assume that the receivables are sold with recourse. Prepare the journal entry for Wood to record the sale, assuming that the recourse liability has a fair value of $7,500.
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