Question

Lucy factored $15,000,000 of accounts receivable with Ethel on a with recourse basis on May 1. (Assume the transaction meets the criteria to be classified as a sale.) Ethel assessed a finance charge equal to 1% of the ARs factored. Ethel retained $100,000 to cover potential sales returns. Lucy estimated her recourse liability to be $495,000. During May and June, customers returned merchandise to Lucy on $90,000 of credit sales. All of the returns related to receivables from the $15,000,000 pool of ARs sold. After taking the returns into consideration, Ethel collected $14,400,000 of the factored receivables. On June 30, Lucy and Ethel “settled up” meaning Lucy and Ethel paid each other any cash that was due to the other.

(a) Prepare the entry Lucy should make on May 1.

(b) Prepare the entry Lucy should make on June 30.

(c) Based on the above facts, what net profit did Ethel end up earning?

(d) Based on the above facts, what net expense did Lucy end up incurring?

Answer 1

Step-by-step explanation

Part-1 journal entry

The entry Lucy should make on May 1 :

Date	General Ledger	Debit ($)	Credit ($)
1-5-xxxx	Cash A/c	14,750,000
	Due from factor a/c (100.000+495,000)	595,000
	Loss on sale of Receivables (finance charge) a/c	150,000*
	To Accounts Receivable a/c		15,000,000
	To Recourse Liability a/c		495,000

.Finance charge = 1% of AR factored = $15,000,000 × 1% = $150,000

Part- 2 Journal entry

Date	General Ledger	Debit ($)	Credit ($)
30-6-xxxx	Cash a/c	195,000
	Recourse liability	495,000
	To Gain on factoring a/c/*		95,000
	To Due from factor a/c		595,000

Gain on factoring = $595,000 ($15,000,000 - $14,400,000-$100,000)

= $595,000 - $500,000.

= $95,000

.

Part-3

Ethel earned the only income of factor charges = 150,000.

.

Part-4

Net expense for Lucy = Factor charges + Bad debt expense + Sales returns

= 150,000+(15,000,000-14,400,000-100,000)+100,000 = 750,000.