CPAnet Forum: Becker question CPA-00673

Active Topics

Memberlist

Help

FAR STUDY GROUP
CPAnet Forum : FAR STUDY GROUP

Topic: Becker question CPA-00673 (

Topic Closed)

Author

Message

<< Prev Topic | Next Topic >>

better_samson
Newbie
Newbie

Joined: 25 Aug 2011
Location: United States
Online Status: Offline
Posts: 11

Posted: 07 Oct 2011 at 23:23 \| IP Logged

Dear all,
I don't understand he answer of this question, here is the question:

On November 1, 1992, Davis Co. discounted with recourse at 10% a one-
year, noninterest bearing, $20,500 note receivable maturing on January
31, 1993. What amount of contingent liability for this note must Davis
disclose in its financial statements for the year ended December 31,
1992?

a. $0 b. $20,000 c. $20,333 d. $20,500

Explanation
Choice "d" is correct. $20,500 contingent liability must be disclosed in its
financial statements at 12-31- 92. The note is not discounted for
footnote liability purposes because Davis is contingently liable for the full
amount because it was sold with recourse.

I understand that receivable and payable within one year is recorded in
face amount, however I am really confused about the contingent liability
and sold with recourse..... I don't know what does it have to do with this
question.

divyagovil1
Major Contributor

Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 09 Nov 2011 at 00:20 \| IP Logged

Notes receivable can be converted into cash by selling
them to a financial institution at a discount. Notes are
usually sold (discounted) with recourse, which means the
company discounting the note agrees to pay the financial
institution if the maker dishonors the note.

When notes receivable are sold with recourse, the
company has a contingent liability that must be
disclosed in the notes accompanying the financial
statements.

A contingent liability is an obligation to pay an amount
in the future, if and when an uncertain event occurs.

In this question, note received by Davis Co. matures on
Jan 31, 1993. However, Davis Co. discounts(sells) it
with recourse on Nov 1, 1992 itself. Since this
note is not due until Jan 31, 1993 and has been
discounted with recourse, it means Davis Co. has assumed
the liability for the note in case the original debtor
defaults on Jan 31, 1993. Since this event is uncertain
whether original debtor would default or not, Davis Co.
discloses $20,500 as contingent liability in its books at
Dec 31, 1992

Let me know if you have any further doubts.

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

better_samson
Newbie
Newbie

Joined: 25 Aug 2011
Location: United States
Online Status: Offline
Posts: 11

Posted: 13 Nov 2011 at 23:30 \| IP Logged

so the 10% is just a distractor , right?

divyagovil1
Major Contributor

Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 14 Nov 2011 at 00:56 \| IP Logged

Yes.... take it this way - 10% is for calculating the PV
and discount on notes receivable in Davis Co's books when
it is received. Cash would be received equivalent to
maturity value.

Bank is not concerned with the PV. It's concerned with the
maturity value at which the N/R is sold to the bank.
Because if the other party defaults, full $20,500 would
have to be repaid to the bank.

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

better_samson
Newbie
Newbie

Joined: 25 Aug 2011
Location: United States
Online Status: Offline
Posts: 11

Posted: 14 Nov 2011 at 21:22 \| IP Logged

Now I get it

Thank you very much, Divya

Sorry, you can NOT post a reply.
This topic is closed.

Printable version

You cannot post new topics in this forum
You cannot reply to topics in this forum
You cannot delete your posts in this forum
You cannot edit your posts in this forum
You cannot create polls in this forum
You cannot vote in polls in this forum