A company regularly sells its receivables to a factor who assesses a 2% service charge on the amount of receivables purchased. Which of the following statements is true for the seller of the receivables?
a. The loss section of the income statement will increase each time receivables are sold.
b. The credit to Accounts Receivable is less than the debit to Cash when the accounts are sold.
c. Selling expenses will increase each time accounts are sold.
d. The other expense section of the income statement will increase each time accounts are sold.
The correct answer and explanation is :
The correct answer is c. Selling expenses will increase each time accounts are sold.
Explanation:
When a company sells its receivables to a factor, it typically receives cash in exchange for the accounts but at a reduced value. This reduction in value is due to the factor’s service charge, which is usually a percentage of the total receivables. In this case, the service charge is 2%.
- Selling Receivables and the Service Charge:
The company sells its accounts receivable at a discount. The factor purchases the receivables and charges a service fee. For example, if the company sells $100,000 of receivables to the factor, the factor will take a 2% fee, or $2,000, leaving the company with $98,000 in cash. - Impact on Selling Expenses:
The 2% fee charged by the factor is considered a selling expense, as it is an expense incurred directly as part of the sale of the receivables. Each time the company sells its receivables, this selling expense increases, as it is directly related to the amount of receivables sold.
- Journal Entry:
- Debit Cash for the amount received (98% of the receivables value).
- Debit Selling Expenses for the service charge (2% of the receivables value).
- Credit Accounts Receivable for the full amount of the receivables sold.
- Why the Other Options are Incorrect:
- Option a: The loss section of the income statement will not necessarily increase each time receivables are sold, as the factor’s service charge is typically accounted for as a selling expense, not a loss.
- Option b: The credit to Accounts Receivable is not less than the debit to Cash because the full amount of the receivables is credited when they are sold, while the cash received is adjusted for the 2% fee.
- Option d: The other expense section does not increase unless the company has specific other expenses, but in this case, the 2% fee is a selling expense, not an “other” expense.
Therefore, the increase in selling expenses with each sale of receivables makes c the correct answer.