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Chapter 7: 6Q (page 362)

What are two methods of recording accounts receivable transactions when a cash discount situation is involved? Which is more theoretically correct? Which is used in practice more of the time? Why?

Short Answer

Expert verified

Two methods of recording transactions of accounts receivables, including cash discount, are:

1. Gross method

2. Net method

Step by step solution

01

Definition of Discount Allowed

Discount allowed can be defined as figures reflecting reduction in the price of goods provided by the seller. It is generally provided for earlier cash payment. It can be classified as trade and cash discounts.

02

Two different methods of recording accounts receivables

1. Gross Method: Under this method, the business entity first records credit sales on gross amount without adjusting the discount provided if payment is made within a specified period. The journal entry will report debit of discount allowed, cash, and credit to accounts receivables on cash receipt.

2. Net method: The business entity reports credit sales after adjusting the discount allowed under net method. This method first reports debit of accounts receivables and credit of sales revenue. A second journal entry reports debit of cash and credit of accounts receivables.

From the theoretical point of view, net method is more reliable because it reports the accounts receivables equal to the amount that can be realized from them.

In practice, business entities generally use gross method because the financial statement representation does not change under this method.

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Most popular questions from this chapter

Arness Woodcrafters sells \(250,000 of receivables to Commercial Factors, Inc. on a with recourse basis. Commercial assesses a finance charge of 5% and retains an amount equal to 4% of accounts receivable. Arness estimates the fair value of the recourse liability to be \)8,000. Prepare the journal entry for Arness to record the sale.

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

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?

(Notes Receivable Journal Entries) On December 31, 2017, Oakbrook Inc. rendered services to Beghun Corporation at an agreed price of \(102,049, accepting \)40,000 down and agreeing to accept the balance in four equal installments of $20,000 receivable each December 31. An assumed interest rate of 11% is imputed.

Instructions

Prepare the entries that would be recorded by Oakbrook Inc. for the sale and the receipts and interest on the following dates (prepare an amortization schedule). (Assume that the effective-interest method is used for amortization purposes.)

(a) December 31, 2017.

(b) December 31, 2018.

(c) December 31, 2019.

(d) December 31, 2020.

(e) December 31, 2021.

3. Which of the following statements is false?

(a) Receivables include equity securities purchased by the company.

(b) Receivables include credit card receivables.

(c) Receivables include amounts owed by employees as a result of company loans to employees.

(d) Receivables include amounts resulting from transactions with customers.

(Notes Receivable with Unrealistic Interest Rate) On December 31, 2015, Ed Abbey Co. performed environmental consulting services for Hayduke Co. Hayduke was short of cash, and Abbey Co. agreed to accept a $200,000 zero-interest-bearing note due December 31, 2017, as payment in full. Hayduke is somewhat of a credit risk and typically borrows funds at a rate of 10%. Abbey is much more creditworthy and has various lines of credit at 6%.

Instructions

(a) Prepare the journal entry to record the transaction of December 31, 2015, for the Ed Abbey Co.

(b) Assuming Ed Abbey Co.鈥檚 fiscal year-end is December 31, prepare the journal entry for December 31, 2016.

(c) Assuming Ed Abbey Co.鈥檚 fiscal year-end is December 31, prepare the journal entry for December 31, 2017.
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