When using the net method of accounting for sales discounts, sales are recorded at the discounted amount. On the date of sale, Hogan should record the sale net of the offered sales discount. The journal entries for this transaction are a debit to accounts receivable and a credit to sales. The rationale is that the amount recorded is what will be received assuming the customer takes advantage of the discount. Although a lower level of revenue is received, offering discounts often speeds up cash flow and may allow Hogan to make investments in the company that may not have been possible otherwise.
When customers fail to take the discount, the cash received in addition to the initial accounts receivable amount will be recorded as “Sales Discounts Forfeited” and shown as other income below the computation of gross profit. Therefore, gross profit as well as sales (and any associated variance calculations) will be understated by the amount of the forfeited sales discount. Net income will remain the same since the extra revenue from the forfeited discounts will be included in its computation.
Trade discounts are price reductions offered to special customers based not on payment terms, but on other factors such as larger quantity purchases and preferential business relationships. The effects of trade discounts are reduced accounts receivable and lowered sales figures. This occurs because at completion of the transaction, sales and accounts receivables will reflect the true substance of the transaction, the net of the sale amount minus the discount. Since trade discounts are not based on terms of payment, they are frequently offered as either an enticement to buy in bulk or, in retail, as a payment for stocking or warehousing the merchandise.
When factored without recourse, Hogan will not receive the full value of the accounts receivable. Full compensation for these accounts is unreasonable since, in these circumstances, the factor bears the risk of the collection. Hogan should account for the factored accounts receivable by a debit to cash for the amount received, a debit to finance charges for the difference between the value of the accounts receivable and the cash paid by the factor. Accounts receivable will require a credit of the full value of the accounts receivable to remove them from the books. The receivables are no longer Hogan’s asset and being on a non-recourse basis, Hogan has no further obligations and the transaction is complete.
Hogan should report three months of interest earned by accrual. The company will debit interest receivable and credit interest income for the 3 months of earned interest. They will also report the full amount of the notes receivable as an asset. If the note receivable is to be paid within the current accounting cycle, it should be listed as a current asset as opposed to a long term asset. The interest revenue, although not collected as of December 31st, must be recognized as revenue in that period as that is the period in which it was earned. To fail to make this adjusting entry would be a violation of the proper matching of revenues and expenses in the period in which they occur as opposed to when they are actually paid. Regarding the note receivable, loans or portions of loans to be collected during the current accounting cycle are to be listed as current assets. This is important especially when dealing with ratios such as Hogan’s current ratio and any other ratios based on total current assets.