Question 8 (15 marks)

Franco Furniture (FF) is a mid-sized owner-operated business that was created 25 years ago by Fred Franco. The retail furniture business is cyclical, with business dropping off in times of economic downturn, as is the case currently. To encourage sales, the store offers its credit cards to good customers. FF has run into a bit of a cash crunch and is planning to go to the bank to obtain an increase in its line of credit to replenish and expand the furniture stock. At present, the line of credit is limited to 70% of the credit card receivables and inventory. The receivables and inventory have been pledged as security for the loan.

Fred has identified two possible sources of the cash shortage: outstanding credit card receivables and a buildup in old inventory. He has come up with two strategies to deal with the problem.

1. Credit card receivables: For the existing receivables, Fred has found the company Factors Inc., which will buy the receivables for 93% of their face value. The two companies are currently negotiating the terms of the deal. So far, FF has agreed to transfer legal title to the receivables to Factors Inc., and FF will maintain and collect the receivables. The one term that is still being discussed is whether Factors Inc. will have any recourse to FF if the amounts become uncollectible.
2. Excess inventory: A new sales promotion has been advertised in the newspaper for the past two months. Under the terms of the promotion, customers do not pay anything upfront and will be able to take the furniture home and begin payments the following year. Response to the advertisement has been very good and a significant amount of inventory has been moved to date, leaving room for new inventory once the bank financing comes through.

Instructions

Assume the role of FFs Controller and advise Fred about the impact of the strategies on the companys financial reporting. FF follows ASPE. Provide the report using the following headings:

1. Overview. (3 marks)
2. Analysis.
   1. Recognition of revenues under the new sales promotion (3 marks)
   2. Transfer of receivables (3 marks)

3. Conclusion and recommendations on each of the analyses. (6 marks)

Please answer all parts.