Problem 24 - Accounting

Question

Journalize the following transactions in the accounts of Lemon Grove Co., which operates a riverboat casino: Mar. 1. Received a \(\$ 30,000,60\)-day, \(6 \%\) note dated March 1 from Bradshaw Co. on account. 18\. Received a \(\$ 25,000,60\)-day, \(9 \%\) note dated March 18 from Soto Co. on account. Apr. 30. The note dated March 1 from Bradshaw Co. is dishonored, and the customer's account is charged for the note, including interest. May 17. The note dated March 18 from Soto Co. is dishonored, and the customer's account is charged for the note, including interest. July 29. Cash is received for the amount due on the dishonored note dated March 1 plus interest for 90 days at \(8 \%\) on the total amount debited to Bradshaw Co. on April \(30 .\) Aug. 23. Wrote off against the allowance account the amount charged to Soto Co. on May 17 for the dishonored note dated March 18 .

Step-by-Step Solution

Answer

Journalize receipt of notes, calculate and record dishonored notes with interest, receive cash with added interest, and write off uncollectibles.

Step 1: Journalizing Receipt of Notes

On March 1, record the receipt of a $30,000, 60-day, 6% note from Bradshaw Co. debit Notes Receivable and credit Accounts Receivable. Similarly, on March 18, record the receipt of a $25,000, 60-day, 9% note from Soto Co. with the same accounts.

Step 2: Recording a Dishonored Note and Charging Customer's Account

On April 30, recognize that the note from Bradshaw Co. is dishonored. Calculate the interest: \[ \text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time} = \\(30,000 \times 0.06 \times \frac{60}{365} = \\)295.89 \]Debit Accounts Receivable for \(30,295.89 (principal + interest) and credit Notes Receivable for \)30,000 and Interest Revenue for $295.89.

Step 3: Dishonored Note from Soto Co.

On May 17, calculate the interest for the Soto Co. note:\[ \text{Interest} = \\(25,000 \times 0.09 \times \frac{60}{365} = \\)369.86 \]Debit Accounts Receivable for \(25,369.86 and credit Notes Receivable for \)25,000 and Interest Revenue for $369.86.

Step 4: Receiving Cash for Dishonored Note with Extended Interest

On July 29, Bradshaw Co. pays the dishonored amount with additional interest for 90 days at 8%. First, calculate the additional interest:\[ \text{Interest} = \\(30,295.89 \times 0.08 \times \frac{90}{365} = \\)595.24 \]Debit Cash for \(30,891.13 (\)30,295.89 + \(595.24) and credit Accounts Receivable for \)30,295.89 and Interest Revenue for $595.24.

Step 5: Write-off Account of Soto Co.

On August 23, recognize the uncollectible amount from Soto Co. by writing it off against the allowance account. Debit Allowance for Doubtful Accounts for $25,369.86 and credit Accounts Receivable for $25,369.86.

Key Concepts

Notes Receivable

Notes Receivable are essentially promises of payment from another party, formalized with a promissory note. When a company, like Lemon Grove Co., receives a note, it acknowledges that an amount is owed to it. This scenario is common when a customer cannot pay immediately and provides a note instead, specifying payment terms. For example, in the exercise, Lemon Grove Co. receives a $30,000 note from Bradshaw Co. and a $25,000 note from Soto Co. The notes are noted as receivables in Lemon Grove Co.'s accounts because they represent potential incoming cash flows. Recording notes receivable involves:

• Debiting the Notes Receivable account (increasing assets with the amount of the note)
• Crediting an account, like Accounts Receivable, reflecting that this note settles previous credit sales

This process helps maintain a clear and accurate picture of expected cash flows.

Interest Calculation

Interest Calculation is critical in financial transactions involving notes. Interest is the cost of borrowing money, calculated as a percentage of the principal over time.Calculating interest involves using the formula: \[ \text{Interest} = \text{Principal} \times \text{Rate} \times \text{Time} \] In the exercise, Lemon Grove Co. calculates interest on notes from Bradshaw Co. and Soto Co. For Bradshaw Co., they determine interest on a \(30,000 note at 6% for 60 days, calculated using:\[ \text{Interest} = 30,000 \times 0.06 \times \frac{60}{365} = 295.89 \]Similarly, they calculate the interest on Soto Co.'s \)25,000 note at 9% for 60 days:\[ \text{Interest} = 25,000 \times 0.09 \times \frac{60}{365} = 369.86 \]Understanding this calculation ensures accurate financial reporting and collection. It also aids in determining the total amount due when the note matures or if it's dishonored.

Accounts Receivable

Accounts Receivable is an asset account reflecting the money owed to a business for credit sales, often recorded when goods or services are provided before payment. It's crucial for cash flow management. Sometimes, notes receivable can become accounts receivable if the note is dishonored, meaning it's not paid on maturity. For instance, when Lemon Grove Co.'s notes from Bradshaw and Soto Co. are dishonored, the amounts, including interest, are transferred back into Accounts Receivable. The steps include:

• Debiting Accounts Receivable with the total amount (note value + accrued interest)
• Crediting Notes Receivable for the note's value
• Crediting Interest Revenue for the earned interest

This reflects the customer's renewed obligation, allowing for continued pursuit of collection or eventual write-off through the allowance method.

Allowance for Doubtful Accounts

Allowance for Doubtful Accounts is a provision used to account for potential credit losses from account receivables. It anticipates which debts are unlikely to be collected, offering a more realistic financial picture. In Lemon Grove Co.'s situation, the note from Soto Co. was eventually written off as uncollectible. This required using the Allowance for Doubtful Accounts. By debiting this allowance, Lemon Grove Co. recognizes the loss and adjusts its financial statements accordingly. Here's how the process works:

• Debit Allowance for Doubtful Accounts to reduce the allowance balance
• Credit Accounts Receivable to remove the specific account balance

This action aligns with the matching principle in accounting, ensuring expenses are recorded in the same period as the related revenues. It's an essential part of responsible financial management, preparing the business for potential credit losses.