Forman Corporation Extends Credit to Its Customers to Purchase Appliances

question 65

Multiple Choice

Forman Corporation extends credit to its customers to purchase appliances, furniture, and other goods.Forman Corporation could borrow from a bank using its accounts receivable as collateral, thereby placing debt on the balance sheet.Forman Corporation would then use the cash collections from the receivables to repay the bank loan with interest.Instead, Forman Corporation sells the accounts receivable to the bank for an amount that is less than the cash the bank expects to collect from receivables purchased.The amount takes account of expected defaults, which would reduce the cash generated by the receivables.This difference between the amount paid to Forman Corporation by the bank for the receivables and the amount that the bank expects to collect from the receivables provides the bank with its expected return. Which of the following is/are true?

• A)Forman Corporation has no further obligation and will treat this transaction as a sale, with no incremental debt on the balance sheet and recognizing bad debt expense on the income statement.
• B)Forman Corporation has further obligations and will treat this transaction as a financing arrangement, recognizing bad debt expense on the income statement.
• C)Forman Corporation has further obligations and will treat this transaction as a financing arrangement, recognizing incremental debt on the balance sheet.
• D)Forman Corporation has no further obligation and will treat this transaction as a sale, with no incremental debt on the balance sheet.
• E)Forman Corporation has further obligations and will treat this transaction as a financing arrangement, recognizing incremental debt on the balance sheet and recognizing bad debt expense on the income statement.

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Definitions:

Depreciation Expense

An accounting method to allocate the cost of a tangible or physical asset over its useful life.

Net Income

The total profit of a company after all expenses and taxes have been subtracted from total revenue; often called the bottom line.

Marginal Rate

The rate at which one additional unit of a variable is accounted for in the cost-benefit analysis, commonly used in the context of taxation and production.

Tax Rate

The fraction of income or profits that an individual or company needs to pay to the government as tax.