If a retailer regularly sells its receivables to a factor, the service charge of the factor should be classified as a(n)
a. selling expense.
b. interest expense.
c. other expense.
d. contra asset.
The correct answer and explanation is :
The correct answer is a. selling expense.
Explanation:
When a retailer regularly sells its receivables to a factor, the service charge that the factor charges should be classified as a selling expense because the transaction is related to the retailer’s regular sales activities. The factor essentially buys the retailer’s accounts receivable (i.e., the amounts owed by customers), and in return, the retailer receives immediate cash (minus a service charge, which is the fee charged by the factor).
In accounting terms, when a retailer sells its receivables, it often does so as part of its ongoing operations to finance its working capital needs. The service charge imposed by the factor represents the cost of obtaining immediate cash for the receivables, which is directly tied to the retailer’s sales process. The charge is essentially a cost of doing business related to the sale of goods or services, making it a selling expense.
Here’s why the other options are incorrect:
- b. Interest expense: An interest expense would relate to the cost of borrowing money, such as when a company takes out a loan or uses a credit line. In this case, the factor’s service charge is not the cost of borrowing money but rather a fee for the service of advancing cash for the receivables.
- c. Other expense: While some expenses may be classified as “other,” the factor’s service charge is directly related to the sales function, so it is more accurately categorized as a selling expense.
- d. Contra asset: A contra asset account is used to reduce the value of an asset (such as an allowance for doubtful accounts). The service charge is not reducing the value of an asset like accounts receivable but is a cost related to selling, so it doesn’t fit into this category.
Thus, the service charge is best classified as a selling expense, as it directly relates to the retailer’s sales process and operations.