Question

(Transfer of Receivables) Use the information for Jones Company as presented in E7-20. Jones is planning to factor some accounts receivable at the end of the year. Accounts totaling \(25,000 will be transferred to Credit Factors, Inc. with recourse. Credit Factors will retain 5% of the balances for probable adjustments and assesses a finance charge of 4%. The fair value of the recourse obligation is \)1,200.

Instructions

(a) Prepare the journal entry to record the sale of the receivables.

(b) Compute Jones’s accounts receivable turnover for the year, assuming the receivables are sold, and discuss how factoring of receivables affects the turnover ratio.

Short answer

The business entity incurs a loss of $2,200 on the sale of receivables.

Step-by-step solution

Definition of Creditors

The individual or business lending cash or from whom the business entity has purchased goods on credit are creditors.

Journal Entry to Record the Sale of Receivable

Date	Accounts and Explanation	Debit $	Credit $
	Cash	$22,750
	Due from factor	$1,250
	Loss on sale	$2,200
	Resource liability		$1,200
	Account receivables		$25,000

Working note:

Computation of cash received:

Particular	Amount $
Accounts receivable	$25,000
Less: Due from factor$\left(\$25,000\times 5\%\right)$	($1,250)
Less: Finance charges$\left(\$25,000\times 4\%\right)$	($1,000)
Cash received	$22,750
Add: Due from factors	$1,250
Less: Resource liability	($1,200)
Net proceeds	$22,800

Computation of loss:

Particular	Amount $
Carrying value	$25,000
Less: Net proceeds	($22,800)
Loss on sale	$2,200

Accounts Receivables Turnover Ratio

After factoring in receivables, the turnover ratio has declined but had declined less than in the previous part. The collection of receivables is slower, but the business entity can convert them into cash.

Receivable’s turnover:

$$\begin{gathered} \mathrm{Receivables}\mathrm{Turnover}\mathrm{Ratio}=\frac{\mathrm{Net}\mathrm{Sales}}{\mathrm{Average}\mathrm{Accounts}\mathrm{Receivables}} \\ =\frac{\$100,000}{{\displaystyle \frac{15,000+\$20,000}{2}}} \\ =\frac{\$100,000}{\$17,500} \\ =5·71\mathrm{times} \end{gathered}$$

Days to collect:

$$\begin{gathered} \mathrm{Days}\mathrm{to}\mathrm{Collect}\mathrm{Receivables}=\frac{365}{\mathrm{Accounts}\mathrm{Receivables}\mathrm{turnover}\mathrm{ratio}} \\ =\frac{365}{5·71} \\ =63·92\mathrm{days} \end{gathered}$$