Chapter 7, Problem 7.7P

(1)

To determine

Discounting of Receivables – Notes payable transactions

Notes Payable is a written promise to pay a certain amount on a future date, with certain percentage of interest. Companies use to issue notes payable to meet short-term financing needs. The principal and interest payments are made as per the following note indenture:

• The issuer agrees to pay total amount on certain terms to the payee.
• The interest is paid on the face value of the notes payable.

To prepare: The journal entries that would be recorded on July 1 for each of the alternatives.

Explanation of Solution

Alternative (a):

To record the signing of notes payable:

Date		Accounts and Explanations	Post Ref.	Debit  ($)	Credit ($)
2016
July	1	Cash		500,000
		Notes Payable			500,000
		(To record issuance of notes payable)

Table (1)

Alternative (b):

Discounting of Receivables: It is another method of financing of receivables. In this method a company may discounts its invoices or promissory notes in any financing company. The financing company deducts some discount and pays the balance amount to that Company.

Discounting of Notes Receivable:

To record the transfer of receivable:

Date		Accounts and Explanations	Post Ref.	Debit  ($)	Credit ($)
2016
July	1	Cash (2)		539,000
		Loss on transfer of Notes receivable (1)		11,000
		Notes Receivable			550,000
		(To record Transfer of Notes receivable)

Table (2)

Working notes:

Compute the amount of loss on transfer of notes receivable:

$\begin{array}{c}\text{Loss on Transfer of Notes Receivable = 2\% of Notes Receivable}\\ \text{ = \$550,000}\times \text{2\%}\\ =\$11,000\end{array}$ (1)

Compute the amount of cash proceeds:

$\begin{array}{c}\text{Cash Proceeds = Face value }-\text{ Loss}\\ \text{=}\text{\$550,000}-\$11,000\\ =\$539,000\end{array}$ (2)

(2)

To determine

To Prepare: The necessary journal entries to record the collection and the remittance to the bank.

Explanation of Solution

Alternative (a):

Cash Collection entry:

Date		Accounts and Explanations	Post Ref.	Debit  ($)	Credit ($)
2016
July		Cash		624,000
		Accounts Receivable			624,000
		(To record the collection from receivables.)

Table (3)

Working notes:

Compute the amount of cash collected from accounts receivable:

$\begin{array}{c}\text{Cash Collection = 80\% of Notes Receivable}\\ \text{ = \$780,000}\times 80\text{\%}\\ =\$624,000\end{array}$

Cash Remittance entry for accounts payable:

Date		Accounts and Explanations	Post Ref.	Debit  ($)	Credit ($)
2016
July	31	Notes Payable		500,000
		Interest Expense  (3)		5,000
		Cash			505,000
		(To record the collection from receivables.)

Table (4)

Working notes:

Compute the amount of interest expense:

$\begin{array}{c}\text{Interest = Principal }\times \text{ Rate of interest }\times \text{ Interest period}\\ \text{ = \$500,000 }\times \frac{12}{100}\times \frac{1}{12}\\ =\$5,000\end{array}$ (3)

Alternative (b)

Out of total receivables of $780,000, the bank held the receivables amounted to $550,000 as the company has transferred it. Hence, the accounts receivables amounted to $\$230,000\left[\$780,000-\$550,000\right]$ is available for collection to the company.

Cash Collection entry:

Date		Accounts and Explanations	Post Ref.	Debit  ($)	Credit ($)
2016
July	31	Cash		184,000
		Accounts Receivable			184,000
		(To record the collection from receivables.)

Table (5)

Compute the amount of cash collected from accounts receivable:

$\begin{array}{c}\text{Cash Collection = 80\% of Notes Receivable}\\ \text{ = \$230,000}\times 80\text{\%}\\ =\$184,000\end{array}$

(3)

To determine

To explain: The required note disclosure that would be included in the July 31, 2016.

Explanation of Solution

For Alternative (a):

The notes payable amounted $500,000 is required to disclose for the assignment of accounts receivable as collateral.

Alternative (b):

As the transfer of receivable was made without resource, no disclosure is required.