Question

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

On August 1, 2021, Hogan factored some accounts receivable on a without recourse basis. Hogan incurred a finance charge.

Hogan 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, 2021, and mature on September 30, 2022. Hogan’s operating cycle is less than one year.

Required:

1a. Using the net method, do sales discounts affect the amount recorded as sales revenue and accounts receivable at the time of sale?
1b. Using the net method, is there an effect on Hogan’s sales revenues and net income when customers do not take the sales discounts?
2. Do trade discounts affect the amount recorded as sales revenue and accounts receivable?
3. Should Hogan decrease accounts receivable to account for the receivables factored on August 1, 2021?
4. Hogan should report the face amount of the interest-bearing notes receivable and the related interest receivable for the period from October 1 through December 31 on its balance sheet as:

Answer 1

Answer:

Requirement 1

a.     Hogan should account for the sales discounts at the date of sale using the net method by recording accounts receivable and sales revenue at the amount of sales less the sales discounts available.

Revenues should be recorded at the cash equivalent price at the date of sale.  Under the net method, the sale is recorded at an amount that represents the cash equivalent price at the date of exchange (sale).

     

b.    There is no effect on Hogan's sales revenues when customers do not take the sales discounts.  Hogan's net income is increased by the amount of interest earned when customers do not take the sales discounts.

Requirement 2

Trade discounts are neither recorded in the accounts nor reported in the financial statements.  Therefore, the amount recorded as sales revenues and accounts receivable is net of trade discounts and represents the cash equivalent price of the asset sold.

Requirement 3

To account for the accounts receivable factored on August 1, 2021, Hogan should decrease accounts receivable by the amount of the accounts receivable factored, increase cash by the amount received from the factor, and record a loss.  Factoring of accounts receivable without recourse is equivalent to a sale.  The difference between the cash received and the carrying amount of the receivables is a loss.

Requirement 4

Hogan should report the face amount of the interest-bearing notes receivable and the related interest receivable for the period from October 1 through December 31 on its balance sheet as current assets.  Both assets are due on September 30, 2022, which is less than one year from the date of the balance sheet.

Hogan should report interest revenue from the notes receivable on its income statement for the year ended December 31, 2021.  Interest revenue is equal to the amount accrued on the notes receivable at the appropriate interest rate.

Interest revenue is realized with the passage of time.  Accordingly, interest revenue should be accounted for as an element of income over the life of the notes receivable.