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7-1

CHAPTER

7

CASH AND RECEIVABLES

Intermediate Accounting IFRS Edition Kieso, Weygandt, and Warfield

7-2

Learning Objectives
1. 2. 3. 4. 5. 6. 7. 8. 9. Identify items considered cash. Indicate how to report cash and related items. Define receivables and identify the different types of receivables. Explain accounting issues related to recognition of accounts receivable. Explain accounting issues related to valuation of accounts receivable. Explain accounting issues related to recognition of notes receivable. Explain accounting issues related to valuation of notes receivable. Understand special topics related to receivables. Describe how to report and analyze receivables.

7-3

Cash and Receivables

Cash

Accounts Receivable
Recognition

Notes Receivable

Special Issues

What is cash?

Recognition

Fair value option

Reporting cash
Summary of cashrelated items

Valuation
Impairment evaluation process

Valuation

Derecognition of receivables
Presentation and analysis

7-4

Cash
What is Cash?
A financial asset—also a financial instrument.
Financial Instrument - Any contract that gives rise to a

financial asset of one entity and a financial liability or
equity interest of another entity.
Illustration 7-1 Types of Assets

7-5

LO 1 Identify items considered cash.

Cash
What is Cash?
? Most liquid asset. ? Standard medium of exchange.

? Basis for measuring and accounting for all other items.
? Current asset.

Examples: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts.

7-6

LO 1 Identify items considered cash.

Cash
Reporting Cash
Cash Equivalents
Short-term, highly liquid investments that are both
(a) readily convertible to cash, and (b) so near their maturity that they present insignificant risk of changes in interest rates.
Examples: Treasury bills, commercial paper, and money market funds.

7-7

LO 2 Indicate how to report cash and related items.

Cash
Restricted Cash
When material in amount:
Segregate restricted cash from “regular” cash. Current assets or non-current assets
Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances.

7-8

LO 2 Indicate how to report cash and related items.

Cash
Bank Overdrafts
When a company writes a check for more than the amount in its cash account.
Generally reported as a current liability.
Offset against cash account only when available cash is present in another account in the same bank on which the overdraft occurred.

7-9

LO 2 Indicate how to report cash and related items.

Cash
Summary of Cash-Related Items
Illustration 7-3

7-10

LO 2

Accounts Receivable
Receivables are claims held against customers and others for money, goods, or services.

Oral promises of the purchaser to pay for goods and services sold.

Written promises to pay a sum of money on a specified future date.

Accounts Receivable

Notes Receivable

7-11

LO 3 Define receivables and identify the different types of receivables.

Accounts Receivable
Non-trade Receivables
1. 2. 3. 4. 5. 6. Advances to officers and employees. Advances to subsidiaries. Deposits to cover potential damages or losses. Deposits as a guarantee of performance or payment. Dividends and interest receivable. Claims against:
a) b) c) d) e) f)
7-12

Insurance companies for casualties sustained. Defendants under suit. Governmental bodies for tax refunds. Common carriers for damaged or lost goods. Creditors for returned, damaged, or lost goods. Customers for returnable items (crates, containers, etc.).
LO 3 Define receivables and identify the different types of receivables.

Accounts Receivable
Non-trade Receivables
Illustration 7-4 Receivables Statement of Financial Position Presentations

7-13

LO 3 Define receivables and identify the different types of receivables.

Accounts Receivable
Recognition of Accounts Receivable
Trade Discounts
Reductions from the list price
Not recognized in the accounting records Customers are billed net of discounts
10 % Discount for new Retail Store Customers

7-14

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Recognition of Accounts Receivable
Cash Discounts
(Sales Discounts)

Inducements for prompt payment Gross Method vs. Net Method

Payment terms are 2/10, n/30

7-15

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Cash Discounts (Sales Discounts)
Illustration 7-5 Entries under Gross and Net Methods of Recording Cash (Sales) Discounts

7-16

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of ?2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. June 3 Accounts receivable 2,000

Sales
June 12 Cash Sales discounts (?2,000 x 2%) Accounts receivable
7-17

2,000
1,960 40 2,000

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of ?2,000 with terms of 2/10, n/60, f.o.b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method. June 3 Accounts receivable 1,960

Sales
June 12 Cash (?2,000 x 98%) Accounts receivable 1,960

1,960

1,960

7-18

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
E7-5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of ?2,000 with terms of 2/10, n/60, f.o.b. shipping point. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the net method, and Arquette did not remit payment until July 29.

June 3

Accounts receivable

1,960

Sales
June 12 Cash Accounts receivable Sales discounts forfeited
7-19

1,960
2,000 1,960 40

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Non-Recognition of Interest Element
A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period.

7-20

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
How are these accounts presented on the Statement of Financial Position? Allowance for Doubtful Accounts 25 Beg.

Accounts Receivable
Beg. 500

End.
7-21

500

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
ABC Corporation Statement of Financial Position (partial) Current Assets: Merchandise inventory Prepaid expense Accounts receivable Less: Allowance for doubtful accounts Cash Total current assets $ 500 (25) 812 40 475 330 1,657

7-22

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
ABC Corporation Statement of Financial Position (partial) Current Assets: Merchandise inventory Prepaid expense Accounts receivable, net of $25 allowance Cash Total current assets $ 812 40 475 330 1,657

7-23

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Journal entry for credit sale of $100?
Accounts receivable Sales 100 100

Accounts Receivable
Beg. 500

Allowance for Doubtful Accounts 25 Beg.

End.
7-24

500

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Journal entry for credit sale of $100?
Accounts receivable Sales 100 100

Accounts Receivable
Beg. Sale 500 100

Allowance for Doubtful Accounts 25 Beg.

End.
7-25

600

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Collected of $333 on account?
Cash Accounts receivable 333 333

Accounts Receivable
Beg. Sale 500 100

Allowance for Doubtful Accounts 25 Beg.

End.
7-26

600

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Collected of $333 on account?
Cash Accounts receivable 333 333

Accounts Receivable
Beg. Sale 500 100 333 Coll.

Allowance for Doubtful Accounts 25 Beg.

End.
7-27

267

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Adjustment of $15 for estimated Bad-Debts?
Bad debt expense Allowance for Doubtful Accounts 15 15

Accounts Receivable
Beg. Sale 500 100 333 Coll.

Allowance for Doubtful Accounts 25 Beg.

End.
7-28

267

25

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Adjustment of $15 for estimated Bad-Debts?
Bad debt expense Allowance for Doubtful Accounts 15 15

Accounts Receivable
Beg. Sale 500 100 333 Coll.

Allowance for Doubtful Accounts 25 15 Beg. Est.

End.
7-29

267

40

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts Accounts receivable 10 10

Accounts Receivable
Beg. Sale 500 100 333 Coll.

Allowance for Doubtful Accounts 25 15 Beg. Est.

End.
7-30

267

40

End.

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts Accounts receivable 10 10

Accounts Receivable
Beg. Sale 500 100 333 10 End.
7-31

Allowance for Doubtful Accounts 25 Beg. Est. 15 W/O 10 30 End.

Coll. W/O

257

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
ABC Corporation Statement of Financial Position (partial) Current Assets: Merchandise inventory Prepaid expense Accounts receivable, net of $30 allowance Cash Total current assets $ 812 40 227 330 1,409

7-32

LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounts Receivable
Valuation of Accounts Receivables
Classification Valuation (cash realizable value) Uncollectible Accounts Receivable Sales on account raise the possibility of accounts not being collected.

7-33

LO 5 Explain accounting issues related to valuation of accounts receivable.

Valuation of Accounts Receivable
Uncollectible Accounts Receivable
An uncollectible account receivable is a loss of revenue that requires, ? a decrease in the asset accounts receivable and ? a related decrease in income and shareholders’ equity.

7-34

LO 5 Explain accounting issues related to valuation of accounts receivable.

Valuation of Accounts Receivable
Methods of Accounting for Uncollectible Accounts

Direct Write-Off Theoretically undesirable:
No matching Receivable not stated at cash realizable value Not IFRS when material in amount

Allowance Method Losses are Estimated:
Percentage-of-sales Percentage-of-receivables IFRS requires when material in amount

7-35

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
Illustration 7-7

Emphasis on the Income Statement

Emphasis on the Statement of Financial Position

7-36

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
Percentage-of-Sales Approach
Percentage based upon past experience and anticipate credit policy. Achieves proper matching of costs with revenues. Existing balance in Allowance account not considered.

7-37

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
Percentage-of-Sales Approach
Illustration: Gonzalez Company estimates from past experience that about 1% of credit sales become uncollectible. If net credit sales are $800,000 in 2011, it records bad debt expense as follows.
Bad Debt Expense Allowance for Doubtful Accounts 8,000 8,000
Illustration 7-8

7-38

LO 5

Uncollectible Accounts Receivable
Percentage-of-Receivables Approach
Not matching.
Reports receivables at cash realizable value.

Companies may apply this method using
? one composite rate, or ? an aging schedule using different rates.

7-39

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
Illustration 7-9 Accounts Receivable Aging Schedule

What entry would Wilson make assuming that no balance existed in the allowance account?

Bad Debt Expense Allowance for Doubtful Accounts
7-40

37,650 37,650

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
Illustration 7-9 Accounts Receivable Aging Schedule

What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?

Bad Debt Expense ($37,650 – $800) Allowance for Doubtful Accounts
7-41

36,850 36,850

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments.

Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable.

7-42

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments.

Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales. (800,000 – 50,000) x 1% = 7,500
Bad Debt Expense Allowance for Doubtful Accounts
7-43

7,500 7,500

LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable
E7-7 (Recording Bad Debts): Sandel Company reports the following financial information before adjustments.

Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (b) 5% of accounts receivable. (160,000 x 5%) – 2,000) = 6,000
Bad Debt Expense Allowance for Doubtful Accounts
7-44

6,000 6,000

LO 5 Explain accounting issues related to valuation of accounts receivable.

Recovery of Uncollectible Accounts
Illustration: Assume that the financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. on March 1, 2012. The entry to record the write-off is:
Bad Debt Expense Accounts Receivable 1,000 1,000

Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries:
Accounts Receivable Allowance for Doubtful Accounts Cash Accounts Receivable
7-45

1,000 1,000 1,000

1,000
LO 5

Accounts Receivable
Impairment Evaluation Process
Companies assess their receivables for impairment each reporting period. Possible loss events are: 1. Significant financial problems of the customer.

2.
3.

Payment defaults.
Renegotiation of terms of the receivable due to financial difficulty of the customer.

4.

Decrease in estimated future cash flows from a group of receivables since initial recognition, although the decrease cannot yet be identified with individual assets in the group.

7-46

LO 5 Explain accounting issues related to valuation of accounts receivable.

Accounts Receivable
Impairment Evaluation Process
A receivable is considered impaired when a loss event indicates a negative impact on the estimated future cash flows to be received from the customer. The IASB requires that the impairment assessment should be performed as follows. 1. Receivables that are individually significant should be considered for impairment separately. Any receivable individually assessed that is not considered impaired should be included with a group of assets with similar credit-risk characteristics and collectively assessed for impairment. 3. Any receivables not individually assessed should be collectively

2.

assessed for impairment.
7-47

LO 5

Accounts Receivable
Illustration: Hector Company has the following receivables classified into individually significant and all other receivables.

Hector determines that Yaan’s receivable is impaired by $15,000, and Blanchard’s receivable is totally impaired. Both Randon’s and Fernando’s receivables are not considered impaired. Hector also determines that a

composite rate of 2% is appropriate to measure impairment on all other receivables.
7-48

LO 5

Accounts Receivable
The total impairment is computed as follows.
Illustration 7-10

7-49

LO 5 Explain accounting issues related to valuation of accounts receivable.

Notes Receivable
Supported by a formal promissory note.
A negotiable instrument.
Maker signs in favor of a Payee. Interest-bearing (has a stated rate of interest) OR Zero-interest-bearing (interest included in face amount).

7-50

LO 6 Explain accounting issues related to recognition of notes receivable.

Notes Receivable
Generally originate from:
Customers who need to extend payment period of an outstanding receivable.
High-risk or new customers. Loans to employees and subsidiaries. Sales of property, plant, and equipment.

Lending transactions (the majority of notes).

7-51

LO 6 Explain accounting issues related to recognition of notes receivable.

Recognition of Notes Receivable
Short-Term Record at Face Value, less allowance Long-Term Record at Present Value of cash expected to be collected
Note Issued at Face Value Premium Discount

Interest Rates

Stated rate = Market rate
Stated rate > Market rate Stated rate < Market rate
7-52

LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value
Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note?
i = 10%
$10,000 Principal

$1,000

$1,000

$1,000 Interest

0
7-53

1
n=3

2

3

4

LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value
PV of Interest

$1,000

x

2.48685
Factor

=

$2,487
Present Value

Interest Received
7-54

LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value
PV of Principal

$10,000
Principal
7-55

x

.75132
Factor

=

$7,513
Present Value

LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value
Summary Present value of interest Present value of principal Note current market value $ 2,487 7,513 $10,000

Date

Account Title

Debit

Credit

Jan. yr. 1 Notes receivable

10,000 10,000 1,000

Cash
Dec. yr. 1 Cash

Interest revenue

1,000

7-56

LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note
Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note?
i = 9%
$10,000 Principal

$0

$0

$0 Interest

0

1
n=3

3

3

4

7-57

LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note
PV of Principal

$10,000
Principal
7-58

x

.77218
Factor

=

$7,721.80
Present Value

LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note
Illustration 7-14

7-59

LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note
Journal Entries for Zero-Interest-Bearing note Present value of Principal $7,721.80

Date Jan. yr. 1 Cash Dec. yr. 1

Account Title Notes receivable

Debit 7,721.80

Credit 7,721.80

Notes receivable Interest revenue ($7,721.80 x 9%)

694.96 694.96

7-60

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. How does Morgan record the receipt of the note?
i = 12%
$10,000 Principal

$1,000

$1,000

$1,000 Interest

0

1
n=3

2

3

4

7-61

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
PV of Interest

$1,000

x

2.40183
Factor

=

$2,402
Present Value

Interest Received
7-62

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
PV of Principal

$10,000
Principal
7-63

x

.71178
Factor

=

$7,118
Present Value

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
Illustration: How does Morgan record the receipt of the note?
Illustration 7-13

Notes Receivable Cash

9,520 9,520

7-64

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
Illustration 7-14

7-65

LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note
Journal Entries for Interest-Bearing Note
Date Beg. yr. 1 Cash End. yr. 1 Account Title Notes receivable Debit 9,520 9,520 Credit

Cash Notes receivable Interest revenue
($9,520 x 12%)

1,000 142 1,142

7-66

LO 6 Explain accounting issues related to recognition of notes receivable.

Notes Receivable
Notes Received for Property, Goods, or Services
In a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or 2. Stated interest rate is unreasonable, or 3. Face amount of the note is materially different from the current cash sales price.

7-67

LO 6 Explain accounting issues related to recognition of notes receivable.

Notes Receivable
Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five-year note having a maturity value of ?35,247 and no stated interest rate. The land originally cost Oasis ?14,000. At the date of sale the land had a fair market value of ?20,000. Oasis uses the fair market value of the land, ?20,000, as the present value of the note. Oasis therefore records the sale as:
(?35,247 - ?20,000) = ?15,247

Notes Receivable

20,000

Land
Gain on Sale of Land

14,000
6,000

7-68

LO 6 Explain accounting issues related to recognition of notes receivable.

Notes Receivable
Valuation of Notes Receivable
Short-Term reporting parallels that for trade accounts receivable. Long-Term - impairment tests are often done on an individual assessment basis. Impairment losses are measured as the difference between the carrying value of the receivable and the present value of the estimated future cash flows discounted at the original effective-interest rate.

7-69

LO 7 Explain accounting issues related to valuation of notes receivable.

Notes Receivable
Illustration: Tesco Inc. has a note receivable with a carrying amount of $200,000. The debtor, Morganese Company, has indicated that it is experiencing financial difficulty. Tesco decides that Morganese’s note receivable is therefore impaired. Tesco computes the present value of the future cash flows discounted at its original effective-interest rate to be $175,000. The computation of the loss on impairment is as follows.

7-70

LO 7 Explain accounting issues related to valuation of notes receivable.

Notes Receivable
The computation of the loss on impairment is as follows.

The entry to record the impairment loss is as follows.
Bad Debt Expense
Allowance for Doubtful Accounts

25,000
25,000

7-71

LO 7 Explain accounting issues related to valuation of notes receivable.

Special Issues Related To Receivables
Fair Value Option
Companies have the option to record fair value in their accounts for most financial assets and liabilities, including receivables. [6] The IASB believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost because it reflects the current cash equivalent value of financial instruments.

[6] International Accounting Standard 39, Financial Instruments: Recognition and Measurement (London, U.K.: International Accounting Standards Committee Foundation, 2003), paras. IN16 and 9.
7-72

LO 8

Understand special topics related to receivables.

Special Issues Related To Receivables
Fair Value Measurement
? Receivables are recorded at fair value. ? Unrealized holding gains or losses reported as part of net income.

? If a company elects the fair value option for a receivable, it must continue to use fair value measurement for that receivable until the company no longer owns this receivable.

7-73

LO 8

Understand special topics related to receivables.

Special Issues Related To Receivables
Fair Value Measurement
? Receivables are recorded at fair value on the statement of financial position. ? Unrealized holding gains or losses reported as part “Other income and expense” on the income statement. ? If a company elects the fair value option, it must continue to use fair value measurement for that receivable.

? If the company does not elect the fair value option at the date of recognition, it may not use this option on that specific receivable in subsequent periods.
7-74

LO 8

Understand special topics related to receivables.

Special Issues Related To Receivables
Illustration (Recording Fair Value Option): Assume that Escobar Company has notes receivable that have a fair value of $810,000 and a carrying amount of $620,000. Escobar decides on December 31, 2011, to use the fair value option for these receivables. This is the first valuation of these recently acquired receivables. At December 31, 2011, Escobar makes an adjusting entry to record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows.

Notes Receivable

190,000 190,000

Unrealized Holding Gain or Loss—Income

7-75

LO 8

Understand special topics related to receivables.

Special Issues Related To Receivables
Derecognition of Receivables
Company may transfer (e.g., sells) a receivables to another company for cash. Reasons: Competition. Sell receivables because money is tight. Billing / collection are time-consuming and costly. Transfer accomplished by:
1.

Secured borrowing

2.
7-76

Sale of receivables
LO 8 Understand special topics related to receivables.

Special Issues Related To Receivables
Secured Borrowing
Using receivables as collateral in a borrowing transaction. Illustration: March 1, 2011, Howat Mills, Inc. provides (assigns) $700,000 of its accounts receivable to Citizens Bank as collateral for a $500,000 note. Howat Mills continues to collect the accounts receivable; the account debtors are not notified of the arrangement. Citizens Bank assesses a finance charge of 1 percent of the accounts receivable and interest on the note of 12 percent. Howat Mills makes monthly payments to the bank for all cash it collects on the receivables.

7-77

LO 8

Understand special topics related to receivables.

Secured Borrowing - Illustration

7-78

Illustration 7-18

LO 8

Secured Borrowing - Exercise
E7-14: On April 1, 2010, Prince Company assigns $500,000 of its accounts receivable to the Hibernia Bank as collateral for a $300,000 loan due July 1, 2010. The assignment agreement calls for Prince Company to continue to collect the receivables. Hibernia Bank assesses a finance charge of 2% of the accounts receivable, and interest on the loan is 10% (a realistic rate of interest for a note of this type). Instructions: a) b) Prepare the April 1, 2010, journal entry for Prince Company. Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2010, through June 30, 2010. On July 1, 2010, Prince paid Hibernia all that was due from the loan it secured on April 1, 2010. Prepare the entry to record this payment.
LO 8 Understand special topics related to receivables.

c)

7-79

Secured Borrowing - Exercise
E7-14 continued
Date (a) Cash Finance Charge Notes Payable ($500,000 x 2% = $10,000) (b) Cash Accounts Receivable (c) Notes Payable Interest Expense Cash (10% x $300,000 x 3/12 = $7,500)
7-80

Account Title

Debit 290,000 10,000

Credit

300,000

350,000 350,000 300,000 7,500 307,500

LO 8

Understand special topics related to receivables.

Sales of Receivables
Factors are finance companies or banks that buy receivables from businesses for a fee.
Illustration 7-19

7-81

LO 8

Understand special topics related to receivables.

Sales of Receivables
Sale without Guarantee
Purchaser assumes risk of collection. Transfer is outright sale of receivable.

Seller records loss on sale.
Seller use Due from Factor (receivable) account to cover discounts, returns, and allowances.

7-82

LO 8

Understand special topics related to receivables.

Sales of Receivables
Illustration: Crest Textiles, Inc. factors 500,000 of accounts receivable with Commercial Factors, Inc., on a non-guarantee (or without recourse) basis. Commercial Factors assesses a finance charge of 3 percent of the amount of accounts receivable and retains an amount equal to 5 percent of the accounts receivable (for probable adjustments). Crest Textiles and Commercial Factors make the following journal entries for the receivables transferred without recourse.
Illustration 7-20

7-83

LO 8

Understand special topics related to receivables.

Sales of Receivables
Sale with Guarantee
Seller guarantees payment to purchaser. Transfer is considered a borrowing—sometimes referred to as a failed sale.
Assume Crest Textiles sold the receivables on a with guarantee basis.
Illustration 7-21

7-84

LO 8

Understand special topics related to receivables.

Summary of Transfers
Illustration 7-22

Determining whether receivables that are transferred can be derecognized and accounted for as a sale is based on an evaluation of whether the seller has transferred substantially all the risks and rewards of ownership of the financial asset.
7-85

LO 8

Presentation and Analysis
General rule in classifying receivables are:
1. Segregate and report carrying amounts of different categories of receivables. 2. Indicate receivables classified as current and non-current in the statement of financial position. 3. Appropriately offset the valuation accounts for receivables that are impaired, including a discussion of individual and collectively determined impairments. 4. Disclose the fair value of receivables in such a way that permits it to be compared with its carrying amount.

5. Disclose information to assess the credit risk inherent in the receivables by providing information on:
6. Disclose any receivables pledged as collateral. 7. Disclose all significant concentrations of credit risk arising from receivables.
7-86

LO 9 Describe how to report and analyze receivables.

Presentation and Analysis
Analysis of Receivables
Illustration 7-24

This Ratio used to:
Assess the liquidity of the receivables.
Measure the number of times, on average, a company collects receivables during the period.

7-87

LO 9 Describe how to report and analyze receivables.

? The accounting and reporting related to cash is essentially the same under both IFRS and U.S. GAAP.
? The basic accounting and reporting issues related to recognition and measurement of receivables are essentially the same between IFRS and U.S. GAAP. ? Although IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. In addition, there is no specific standard related to pledging, assignment, or factoring.
7-88

? Like the IASB, the FASB has worked to implement fair value measurement for all financial instruments, but both Boards have faced bitter opposition from various factions. As a consequence, the Boards have adopted a piecemeal approach in which disclosure of fair value information in the notes is the first step. The second step is the fair value option, which permits companies to record fair values in the financial statements. Both Boards have indicated that they believe all financial instruments should be recorded and reported at fair value.

7-89

? IFRS and U.S. GAAP standards on the fair value option are similar but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered.
? IFRS and U.S. GAAP differ in the criteria used to derecognize a receivable. IFRS is a combination of an approach focused on risks and rewards and loss of control. U.S. GAAP uses loss of control as the primary criterion.
7-90

Management faces two problems in accounting for cash transactions: 1. Establish proper controls to prevent any unauthorized transactions by officers or employees. 2. Provide information necessary to properly manage cash on hand and cash transactions.

7-91

LO 10 Explain common techniques employed to control cash.

Using Bank Accounts
To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts.
? General checking account ? Collection float. ? Lockbox accounts

? Imprest bank accounts

7-92

LO 10 Explain common techniques employed to control cash.

The Imprest Petty Cash System
To pay small amounts for miscellaneous expenses.

Steps:
1. Record $300 transfer of funds to petty cash: Petty Cash Cash 300 300

2. Petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.
7-93

LO 10 Explain common techniques employed to control cash.

The Imprest Petty Cash System
Steps:
3. Custodian receives a company check to replenish the fund. Office Supplies Expense Postage Expense 42 53

Entertainment Expense
Cash Over and Short Cash

76
2 173

7-94

LO 10 Explain common techniques employed to control cash.

The Imprest Petty Cash System
Steps:
4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows. Cash Petty cash 50 50

7-95

LO 10 Explain common techniques employed to control cash.

Physical Protection of Cash Balances
Company should
? ? ? ? ? Minimize the cash on hand. Only have on hand petty cash and current day’s receipts. Keep funds in a vault, safe, or locked cash drawer. Transmit each day’s receipts to the bank as soon as practicable. Periodically prove (reconcile) the balance shown in the general ledger.

7-96

LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances
Schedule explaining any differences between the bank’s and the company’s records of cash.

Reconciling Items:
1. Deposits in transit.

2. Outstanding checks.
3. Bank charges and credits. 4. Bank or Depositor errors.

Time Lags

7-97

LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances

Illustration 7A-1 Bank Reconciliation Form and Content

7-98

LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances

7-99

LO 10

Illustration 7A-2

7-100

LO 10 Explain common techniques employed to control cash.

Illustration: Journalize the adjusting entries at November 30 on the books of Nugget Mining Company. Nov. 30 Cash 542

Office expense
Accounts receivable Accounts payable

18
220 180

Interest revenue

600

7-101

LO 10 Explain common techniques employed to control cash.

Review Question
The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks. b. deposit in transit. c. a bank error.

d. bank service charges.

7-102

LO 10 Explain common techniques employed to control cash.

Companies assess their receivables for impairment each reporting period. Examples of possible loss events are: ? Significant financial problems of the customer.

? Payment defaults.
? Renegotiation of terms of the receivable.
In this appendix, we discuss impairments based on the individual assessment approach for long-term receivables.

7-103

LO 11 Describe the accounting for a loan impairment.

Impairment Measurement and Reporting
Impairment loss is calculated as the difference between: ? the carrying amount (generally the principal plus accrued interest) and ? the expected future cash flows discounted at the loan’s historical effective-interest rate.

In estimating future cash flows, the creditor should use reasonable and supportable assumptions and projections.

7-104

LO 11 Describe the accounting for a loan impairment.

Impairment Loss Example
Impairment loss is calculated as the difference between: ? the carrying amount (generally the principal plus accrued interest) and ? the expected future cash flows discounted at the loan’s historical effective-interest rate.

In estimating future cash flows, the creditor should use reasonable and supportable assumptions and projections.

7-105

LO 11 Describe the accounting for a loan impairment.

Illustration: At December 31, 2010, Ogden Bank recorded an investment of $100,000 in a loan to Carl King. The loan has an historical effective-interest rate of 10 percent, the principal is due in full at maturity in three years, and interest is due annually. The loan officer performs a review of the loan’s expected future cash flow and utilizes the present value method for measuring the required impairment loss.
Illustration 7B-1

7-106

LO 11 Describe the accounting for a loan impairment.

Illustration: Computation of Impairment Loss
Illustration 7B-2

Recording Impairment Losses
Bad Debt Expense Allowance for Doubtful Accounts 12,434 12,434

7-107

LO 11 Describe the accounting for a loan impairment.

Recovery of Impairment Loss
Illustration: Assume that in the year following the impairment recorded by Ogden, Carl King has worked his way out of financial difficulty. Ogden now expects to receive all payments on the loan according to the original loan terms. Based on this new information, the present value of the expected payments is $100,000. Thus, Ogden makes the following entry to reverse the previously recorded impairment.

Allowance for Doubtful Accounts
Bad Debt Expense
7-108

12,434
12,434

LO 11 Describe the accounting for a loan impairment.

Copyright
Copyright ? 2011 John Wiley & Sons, Inc. All rights reserved.

Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful.

Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

7-109


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