Question

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’s list price. Each note’s stated interest rate is below the customer’s 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

At December 31, 2017, how should Corrs measure and account for the impact of estimated losses resulting from notes receivable that it

(1) Retained and did not sell?

(2) Sold to bank with recourse?

Short answer

Bad debt expenses must be recognized using the aging method when the business entity retains receivables. When receivables are sold using resource liability, it will increase the loss of the business entity because it is reported on the credit side.

Step-by-step solution

Definition of Equipment

Equipment can be defined as the resource or any tool used by the business entity in the production process or essential business function. It is reported as a fixed asset of the business.

Measure and Accounting for Estimated Loss

1. For notes receivable not sold: In this case, the business entity will recognize bad debt expenses by using the aging method or discounted cash flow. The amount of bad debt expenses equals the difference of allowance for doubtful accounts and the amount recovered from the equipment.

2. Sold to bank with the resource: In this case, the business entity will report resource liability on the credit side. The liability will be used to measure the bad debts at the time of sale of receivable and increase the loss for the business entity.