Lonergran Company occasionally uses its accounts receivable to obtain immediate

Question

Lonergran Company occasionally uses its accounts receivable to obtain immediate cash. At the end of June 2011, the company had accounts receivable of $780,000. Lonergran needs approximately $500,000 to capitalize on a unique investment opportunity. On July 1, 2011, a local bank offers Lonergran the followingg two alternatives.

a) Borrow $500,000, 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 $550,000 of specific receivables to the bank without recourse. The bank will charge 2% finance charge on the amount of receivables transferred. The bank will collect the receivables directly from the customers. The sale criteria are met.

1. Prepare the journal entries that would be recorded on July 1 for each of the alternatives.

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

3. For each alternative, explain and required note disclosures that would be included in the July 31, 2011 financial statements.

Explanation / Answer

(1)   Alternative b:

July 1, 2011:

Cash ($550,000 x 98%) = 539,000

Loss on transfer of receivables (2% x $550,000) = 11,000 (2)

Alternative a: July, 2011:

Cash (80% $780,000) = 624,000

July 31, 2011:

Interest expense ($500,000 x 12% x 1/12) = 5,000

Alternative b: $550 of accounts receivable are now held by the bank, and presumably the bank has collected .8 $550 = $440 during July

. Lonergan still holds accounts receivable of ($780 -$550 = $230), so should have collected .8 $230 = $184 during July.

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