I am new to double-entry bookkeeping and would like to know how I would account for the following...
The business is based on doing "work" on a customers asset. For this we want to accept the asset we will do work on, and pay a percentage of the assets value back to the customer as an insurance.
Scenario 1 (Asset value 1,000, Collateral 750)
We accept the asset from the customer which is worth 1,000
We then give the customer 750 in cash as an insurance.
When the job is complete the customer returns our 750 in cash.
We then return their asset worth 1,000.
As the collateral is less than the asset I am not sure how I would post this onto the accounts using double entry. The complexity seems to be that as we have only insured the asset for 75% of its value, I cannot make a posting to the customers account giving them a credit for the asset value. And then the accounting equation does not add up.
Scenario 2 (Asset value 1,000, Collateral 750, Job Value 100)
Slightly more complex, in this example we want to charge the customer up front for the job.
We accept the asset from the customer.
We then give the customer 650 (750 collateral less the 100 cost of doing the work).
When the job is complete the customer pays us 750.
We return their asset worth 1,000.
Again, I am looking for a way I could account for this using double entry and the appropriate accounts to post to.
It seems to follow the criteria of being a short term loan secured on assets.
There is no profit motive for your business as there is no payment, only a return of capital.
In the real world this would have the hallmark of a related party transaction.
As this seems to be an academic excercise rather than there being any commercial sense to it the key is that you will never own the asset. You have not purchased it, the risk and reward of ownership do not reside with you.
The only commercial transaction (said in the vaguest possible sense of the word!) is the loan which is :
Cr Bank £750
Dr Client Loan Account £750
On repayment
Cr Client Loan Account £750
Dr Bank £750
There is no sale to speak of.
If your tutor mentions anything about recognising the £1000 ask them where they believe the risk and reward of ownership lies.
Similar story with the second scenario.
The risk and reward of ownership of the asset never passes to you so you do not recognise the asset in your financial statements unless the client defaults payment when ownership would (I assume as part of the written agreement) transfer.
Cr Bank £650
Dr Client loan account £650
To keep the sale recorded you would record :
Cr Sales account £100
Dr Client account £100
On Repayment of the £750.
Dr Bank £750
Cr Client loan account £650
Cr Client account £100
Note that for the loan account you could just as easily say customer deposit account.
The loose end in there is the Sales account which is balanced off at the period end to record the sales for the period.
If your course recognises the asset then it is wrong as the risk and reward of ownership does not transfer and the collateral is only a loan arrangement unless defaulted.
Which course is it you are taking and who with? Exposure to this sort of scenario would indicate that you already have some knowledge of financial reporting standards and accounting principles before bookkeeping.
If the course recognises the asset used as collateral then there is a flaw with the course.
kind regards,
Shaun.
p.s. don't act on the above yet. Give others chance to disagree with my appraisal of the scenario... Hope that this was just course work and not an exam question.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
An example of my business is as follows (please bare with me!):
My clients would give me high value items which they wish to have "improved" - for example, giving me a diamond that they want to have polished. Due to the high value of the items I must give them collateral based on the item value which in my example above was 75%. I am additionally paid up front which is a specific of the industry I am in.
I am new to book keeping so just wanted to try and understand how I would account for such scenarios. It would appear from the initial answer that the customers item would not be registered into my asset register until the customer defaults.
I hope that I can still ask questions here as this is not an academic question.
I think the above works from the point of having a 'control' in place, i.e. so you know what you are owed at any given time, however I'm not so certain it's the best treatment from an accounting point of view if there was an outstanding amount at the year end as there will be a debtor on the client loan account but nothing that represents the fact that you have the asset.
I wonder if you would need to add a 'collateral stock' and a 'collateral(loan?) account or some such thing. So you could go with :
so at the period end there would show a collateral/loan a/c that was a creditor of £350 (as opposed to a debtor of £650 in your example) but also a debit stock figure (albeit Collateral) of £1000.
I don't like it, it seems messy and over complicated so hopefully someone clever will come up with a better solution!
but taking the £1k into consideration assumes that it should every toucj the records of the business which to my mind it shouldn't as its something put up as a guarantee, risk and reward of ownership never transfer (unless there is a default) in which case it becomes inventory.
Consider this (I know that the amounts are unlikely to be material but bear with me), if the collateral is held over a period end then the financial statements will be overstated by assets not belonging to the entity.
Hi Remotec,
not sure which bit of mine you may have missed but you were also up £100 on the sales account in my approach.
With your method you are losing the link between the client and the sale and only retaining the lnk between the client and the deposit.
Go back through mine with a set of T accounts and you will see what I mean.
Kind regards to both,
Shaun.
__________________
Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
I don't disagree apart from it being stated that the asset remains if he doesn't get paid for it, but I still think you are right that ownership hasn't been transferred. An unusual situation that hopefully won't crop up with any of my diamond polisher clients!
