Reference no: EM132591892

Bottle Extravaganza Corp. (BE) manufactures water bottles for athletes and does its financial reporting once a year at the end of the calendar year. The company allows customers to pay on account. In 2015, BE accumulated $250 in credit sales and collected $40 on account. The company wrote off $100 for specific accounts determined to be uncollectible. BE uses the aging of accounts method to estimate bad debts, and estimated the balance in the allowance for doubtful accounts (ADA) for December 31, 2015 to be $50.

On December 31, 2014, the company had balances of $100 of gross accounts receivable and $50 in the ADA. All customers have until December 31, 2017 to pay back their debt to BE.

Question a. Provide the journal entry to record bad debt expense for the year 2015.

Question b. Provide an intuitive explanation for the bad debt expense number in this particular problem (not the concept). What are its sources? (Hint: draw a T-account of the ADA and interpret its evolution.)

The CFO of BE considers transferring the risk of customer payment default in the receivables to another firm called WARE through two transactions described in parts c) and d) below.

Question c. Transaction W: On January 1, 2016, BE could transfer all receivables to WARE in exchange for $150 cash plus the promise to compensate WARE for any default up to $50.

What kind of transaction does the promise feature resemble?

The CFO of BE considers transferring the risk of customer payment default in the receivables to another firm called WARE through two transactions described in parts c) and d) below.

Question d. Transaction H: Alternatively, on January 1, 2016, BE could transfer all receivables to WARE in exchange for $100 cash plus a $50 holdback.

What type of problem is a holdback feature meant to address? Because of the holdback, what will the accounting treatment (type of transaction) of this transaction be?

Question e. Describe the main economic difference between transactions W and H from BE's perspective? What is the difference in risk to BE from these two transactions? Which of the two transactions is BE more likely to execute, and why? Hint: Think about the cash-flow of the transactions.

By December 31, 2016, BE estimates the default risk of all receivables to be $50 (assuming BE executed either transaction W or H during 2016).

Question f. Provide all journal entries of transaction H for BE during 2016. (Hint: think about which risks exist for BE and how they should be accounted for.)

Question g. Provide all journal entries of transaction H for BE during 2017, assuming that customer defaults of $20 occur during 2017, and WARE settles with BE in full.

Question h. Provide all journal entries of transaction W for BE during 2016, assuming the transaction will be treated as a financing transaction.

Question i. Provide all journal entries of transaction W for BE during 2017, assuming that customer defaults of $20 occur during 2017.