Chapter 6: Cash and Receivables

Part I

When a company has a policy of making sales for which credit is extended, it is reasonable to expect a portion of those sales to be uncollectible. As a result, a company must recognize bad debt expense. The two methods of recognizing bad debt expense are the (1) direct write-off method and (2) allowance method.

Required:

1. Describe fully both the direct write-off method and the allowance method of recognizing bad debt expense.

2. Explain the reasons why one of these methods is preferable to the other and the reasons why the other method is not usually in accordance with generally accepted accounting principles.

Part II

C6-12 Researching GAAP (Using Codification)

Situation

Hamilton Company operates in an industry with numerous competitors. It is experiencing a shortage of cash and decides to obtain money from a large bank by using some of its receivables as collateral. Hamilton pledges $100,000 of its receivables, is charged a 12% fee on this amount, and notifies these credit customers to make their payments directly to the bank. Hamilton transfers the receivables to the bank, and the bank assumes the servicing activities, but Hamilton is responsible for all bad debts which it reasonably estimates to be 2% of the receivables amount. When the balance of the receivables pledged is reduced to $3,000, Hamilton is required to repurchase the receivables, notify the remaining credit customers to make payments to it, and reassume the servicing activities. The bank has the right to sell the receivables, except to Hamiltons major competitor. Hamiltons president has asked you how to account for (and record) this transaction.

Directions

Research the related generally accepted accounting principles and prepare a short memo to the president that answers his question. Cite your reference and applicable paragraph numbers.