Sfas 77 lists three conditions that must be met if a

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SFAS #77 lists three conditions that must be met if a transfer with recourse is to be accounted for as a sale: 1. Transferor surrenders control of the receivables; 2. Obligations of transferor, if any (e.g., "with recourse" provisions) are estimable; 3. Requirement of repurchase by transferor is limited (to avoid sham sales transactions). Whether the transfer is a sale or a borrowing, discounting a N/R at the bank involves several steps: 1. Compute the note's maturity value = face value if non-interest bearing, or the face value + interest if interest-bearing. 2. Compute the bank's discount = (Bank's discount rate) x (maturity value) x (remaining time to maturity). We’ll use this simple approach to illustrate the basic idea, even though present value techniques (modified by the bank’s search for a meaningful profit margin) are used in actual practice. 3. Compute the proceeds from the bank: Note's maturity value - bank's discount = proceeds: (1) - (2) 4. Compute the carrying value of the note on the transferor's books (with accrued interest up to the date of transfer). 5. Compute the gain or loss (assume it is a sale) as follows: Cash proceeds - carrying value 6. Prepare the journal entry to record the transfer of the N/R.
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Chapter 7, p. 16 Example of discounting a note receivable: On 5/1/03, ABC Company received a $10,000, 120-day non-interest- bearing note from one of its customers in exchange for equipment. The market interest rate on 5/1/03 for similar notes was 12%. The note was discounted at Bank One on 7/1/03. Bank One used a 14% discount rate. Required: Prepare the 5/1/03 and 7/1/03 journal entries on ABC's books. Assume that the note is discounted without recourse, and hence is treated as a sale. 1. Notes maturity value = 10,000 2. Banks Discount = .14*2/12*10,000= 233.33 3. Proceeds= 10,000-233.33= 9,766.66 4. Book Value of N/R at origination = 9,600 (10,000 – 400) 5. Book Value of N/R at time of sale to Bank One = 9,800 (200 Disc N/R) Monthly interest is 1% (12%/12). So must determine implied interest of 1% per month for 4 periods ($400). Then, in part 2 when you sell to Bank One, write off the $200 discount on N/R. JOURNAL ENTRY: 5/1/03 N/R 10,000 Discount on N/R 400 Sales Rev. 9,600 Recognize interest earned for the two months which ABC held N/R 5/31/03 Discount on N/R 100 Interest Revenue 100 6/30/03 Discount of N/R 100 Interest Revenue 100 ABC sells (factors) N/R with Bank One 7/1/03 Cash 9,766.66 Discount on N/R 200.00 Loss on sale 33.34 Notes Receivable 10,000
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