Question

Lonergan Company occasionally uses its accounts receivable to obtain immediate cash. At the end of June 2021, the company had accounts receivable of $860,000. Lonergan needs approximately $540,000 to capitalize on a unique investment opportunity. On July 1, 2021, a local bank offers Lonergan the following two alternatives:
a. Borrow $540,000, sign a note payable, and assign the entire receivable balance as collateral. At the end of each month, a remittance will be made to the bank that equals the amount of receivables collected plus 12% interest on the unpaid balance of the note at the beginning of the period.
b. Transfer $590,000 of specific receivables to the bank without recourse. The bank will charge a 2% factoring fee on the amount of receivables transferred. The bank will collect the receivables directly from customers. The sale criteria are met. Required:

1. Prepare the journal entries that would be recorded on July 1 for:
a. alternative a. b. alternative

2. Assuming that 80% of all June 30 receivables are collected during July, prepare the necessary journal entries to record the collection and the remittance to the bank for:
a. alternative a.
b. alternative b.

Answer 1

Answer:

1 a) Debit Bank $540000, Credit Note payable $540000

no accounting entry for the collateral of Accounts receivable.

b) Debit Bank $590000, Credit Accounts receivable $590000

  Debit Factoring fee $11800 Credit Bank $11800

2 a) Debit bank $540000, Credit Note payable $540000

   Debit Note Payable $540000, Credit Accounts receivables $540000

no interest of 12% because full amount is paid at once.

b) Debit Bank $590000, Credit Accounts receivable $590000

  Debit Factoring fee $11800 Credit Bank $11800

  Debit bank $98 000, Credit Accounts receivables $98000

   

Explanation:

When the company transfers 590000 accounts receivable it is as if it has collected them and especially when there is no recourse and when they are collected they belong to the bank as the bank would have collected the money straight from customers. When 80% is collected on the remaining balance from 688000- 590000= 98000 is collected and is money for the company.

The 80% collection is more than the $540000 loan so the loan is paid at once and no interest on the remaining loan balance as is zero.