A firm has booked as a sale, the transfer of $10 million in short-term accounts receivable to Public Finance Co., subject to recourse. The notes to the financial statements disclose that as of the end of the fiscal year, $8 million remained uncollected. In order to reflect this on the balance sheet, which of the following adjustments must be made? A) Decrease retained earnings and increase accounts receivable. B) Increase accounts receivable and increase current liabilities. C) Decrease cash and increase accounts receivable. I thought the Answer would be C but B was the right answer. Any explanation?
What’s the difference betwen your answer and the correct one? Cash
You wouldn’t want to hit cash until you actually make the payment. Until then, it is an amount owed (liability). Then, when you do pay, you clear the liability (DR Laibility, CR Cash)
As a practical matter, you’d want to see the contract required you to do. But of the given answers, B is best.
When we sold the receivables, we decreased AR and increased Cash
If the receivables are not collected, shouldnt we reverse the process?
When you sell receivables _ with recourse _, what you’re doing, in essence, is borrowing money and offering the receivables as collateral. As an analyst, you should make the balance sheet conform to the essence of the transaction:
- Leave Cash unchanged, as you would receive the same amount of cash either way
- Restore Accounts Receivable to the balance sheet, as you would have retained them if they were merely serving as collateral
- Add a Liability (Loans Payable, Notes Payable, whatever) to acknowledge that you have a legal obligation to make good on the uncollectable receivables
Yes. But when was the cash sent back? If it has already been sent (before fiscal year end) then yes answer c is correct. But if it hasn’t, which appears to be the case, then you can’t decrease cash on your books. You show it as a liability until paid.