Mel-Tim Corporation has a $100,000 debt payment due in early August. In order to meet this obligation, on August 1, Mel-Tim decided to accelerate collection of accounts receivable by assigning $130,000 of specific accounts to a commercial lender as collateral for a loan. Under the agreement, Mel-Tim guarantees the accounts and will notify its customers to make their payments to the lender. In return, the lender will advance Mel-Tim 85% of the accounts assigned. The remaining 15% will be paid to Mel-Tim once the commercial lender has recovered its fees and related cash advances. The lender receives a fee of the total accounts assigned, which is immediately deducted from the initial cash advance. The lender also assesses a monthly finance charge of one half of 1% on any uncollected account balances. Finance charges are to be deducted from the first payment due Mel-Tim after the lender has recovered its cash advances.

Question

Mel-Tim Corporation has a $100,000 debt payment due in early August. In order to meet this obligation, on August 1, Mel-Tim decided to accelerate collection of accounts receivable by assigning $130,000 of specific accounts to a commercial lender as collateral for a loan. Under the agreement, Mel-Tim guarantees the accounts and will notify its customers to make their payments to the lender. In return, the lender will advance Mel-Tim 85% of the accounts assigned. The remaining 15% will be paid to Mel-Tim once the commercial lender has recovered its fees and related cash advances. The lender receives a fee of the total accounts assigned, which is immediately deducted from the initial cash advance. The lender also assesses a monthly finance charge of one half of 1% on any uncollected account balances. Finance charges are to be deducted from the first payment due Mel-Tim after the lender has recovered its cash advances.

On August 31, Mel-Tim received a statement from the lender saying it had collected $80,000. On September 30, Mel-Tim receives a check from the lender together with a second statement saying an additional $40,000 has been collected.

Required:

a. State whether this is a collateralized borrowing, factoring with recourse or factoring with out recourse. Explain your decision briefly.
b. Prepare all necessary journal entries.

Answer 1

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Answer 2

a. This is a factoring with recourse arrangement. In factoring with recourse, the company retains the risk of collectability of the accounts receivable assigned to the lender. This means that if the customers fail to pay, Mel-Tim will be responsible for reimbursing the lender. In this case, Mel-Tim guarantees the accounts and will notify its customers to make their payments to the lender. Therefore, Mel-Tim retains the risk of collectability and it is a factoring with recourse arrangement.

b. The necessary journal entries are as follows:

August 1:
Debit: Cash (85% of $130,000)
Credit: Accounts Receivable - Assigned (85% of $130,000)

August 1:
Debit: Due to Lender (Assignment Fee)
Credit: Cash (Assignment Fee)

August 31:
Debit: Due from Lender (Collections)
Credit: Accounts Receivable - Assigned (Collections)

August 31:
Debit: Finance Charge Expense (0.5% of uncollected account balances)
Credit: Due from Lender (Finance Charges)

September 30:
Debit: Due from Lender (Collections)
Credit: Accounts Receivable - Assigned (Collections)

September 30:
Debit: Finance Charge Expense (0.5% of uncollected account balances)
Credit: Due from Lender (Finance Charges)

September 30:
Debit: Due from Lender (Remaining 15%)
Credit: Accounts Receivable - Assigned (Remaining 15%)

At the end of each period, the finance charge expense is calculated as 0.5% of the uncollected account balances and is recorded as an expense. The collections received from the lender are recorded as a reduction of the assigned accounts receivable. The remaining 15% of the assigned accounts receivable is recorded as a credit to the assigned accounts receivable and a debit to the due from the lender account.