Kate Miller owns a dance studio in Los Angeles, California. Students can buy access to the dance classes by paying a monthly fee. Unfortunately, many of Kate’s students are struggling actors and actresses who lack the ability to pay their bills in a timely manner. And, although the students were expected to pay for classes in advance, Kate began offering credit to many of her students to grow her business.

This, however, has put Kate in a serious liquidity problem as revealed by the growing balance in the studio’s outstanding accounts receivable:

Kate’s accountant, Matt Thomas, tried to help her get a handle on the studio’s accounts receivable problem, but to little avail. One trick he successfully used in the past to make Kate realize the seriousness of the problem was to overestimate the extent of Kate’s bad debt problem; consequently, there currently exists a balance in the allowance for uncollectible accounts totaling \($2,700\).
Required
1. The first step to help get Kate’s business back on track is to write off all receivables having a very low probability of collection (those accounts over 150 days). What balance sheet accounts will be affected, and in what amount, when Matt executes this action?
2. Prepare an aging of Kate’s remaining accounts receivable. What balance should be in the allowance for uncollectible accounts account?
3. Kate is in need of an immediate cash infusion and Matt has advised her to sell some of her receivables.
A local bank has offered her two alternatives:

a. Factor \($40,000\) of “current” receivables (O—30 days old) on a nonrecourse basis at a flat fee of eleven percent of the value of the receivables sold.

b. Factor \($40,000\) of “current” receivables on a recourse basis at a flat fee of six percent of the value of the receivables sold.
Which option should Kate choose? Why?

Transcribed Image Text:

Age Classification 0-30 days.. 31-60 days. 61-90 days. 91-120 days. 121-150 days. > 150 days Accounts Receivable Outstanding Balance $44,000 Historical Estimate of Non-Collection 4% 8 31,000 22,000 12 13,000 14 9,000 20 5,000 50