Vernon Furniture factors $600,000 of receivables to Fast Factors, Inc. Fast Factors assesses a 2% service charge on the amount of receivables sold. Vernon Furniture factors its receivables regularly with Fast Factors. What journal entry does Vernon make when factoring these receivables?
a. Cash 588,000 Loss on Sale of Receivables 12,000 Accounts Receivable 600,000
b. Cash 588,000 Accounts Receivable 588,000
c. Cash 600,000 Accounts Receivable 588,000 Gain on Sale of Receivables 12,000
d. Cash 588,000 Service Charge Expense 12,000 Accounts Receivable 600,000
The correct answer and explanation is :
The correct journal entry Vernon Furniture should make when factoring its receivables is:
a. Cash 588,000 Loss on Sale of Receivables 12,000 Accounts Receivable 600,000
Explanation:
When Vernon Furniture factors its receivables to Fast Factors, it sells its receivables for immediate cash. However, Fast Factors charges a service fee (2% in this case) for handling the receivables. This means that Vernon will receive less than the full value of the accounts receivable sold, reflecting a loss due to the service charge.
Here’s how to break it down:
- Accounts Receivable (600,000): Vernon Furniture is factoring $600,000 worth of receivables. So, the first step is to remove the receivables from its books, which is reflected by a credit to the Accounts Receivable account for the full amount of $600,000.
- Service Charge (2% of $600,000): Fast Factors charges a 2% service fee. The amount of the service charge is calculated as:
[
600,000 \times 0.02 = 12,000
]
This service charge is deducted from the total receivables and becomes an expense for Vernon. The service charge represents the cost of factoring the receivables and is recorded as a Loss on Sale of Receivables. - Cash (588,000): After the service charge, Vernon Furniture will receive the remaining amount in cash, which is:
[
600,000 – 12,000 = 588,000
]
This amount is recorded as a debit to the Cash account.
So, the journal entry is:
- Debit Cash for the amount Vernon receives, which is $588,000.
- Debit Loss on Sale of Receivables for the $12,000 service charge.
- Credit Accounts Receivable for the full amount of receivables, which is $600,000.
This reflects the loss incurred due to the factoring fee and the removal of receivables from Vernon’s books.