Chapter 7 Cash and Receivables ACCT-30301. 1. Cash Few problems ◦ easy valuation and...

Chapter 7

Cash and Receivables

ACCT-3030 1

1. Cash Few problems

◦ easy valuation and classification◦ requires significant controls (Appendix 7A)

Petty cash (Appendix 7A) Bank reconciliations (Appendix 7A)

◦ BE 7-15 Restrictions on cash

◦ disclosure◦ presentation◦ compensating balances

Cash equivalents◦ highly liquid investments◦ 3 months or less maturity

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1. Cash

ACCT-3030 3

Illustration 7-2

2. Accounts and Notes Receivable

Receivables◦claims held against customers and others for

money, goods, or servicesA/R – oral promises to payN/R – written promises to pay

◦a negotiable instrumentTrade vs. Nontrade receivables

◦ trade – customers◦nontrade – officers, stockholders, affiliates,

depositsACCT-3030 4

3. A/R – Bad DebtsBad debts

◦uncollectible accounts receivableTwo methods of accounting

◦direct write-off method (not GAAP) does not apply matching

◦allowance method (GAAP) correctly applies matching reflects proper YE carrying value of A/R

ACCT-3030 5

3. A/R – Bad DebtsDirect write-off method

◦expense recorded when account deemed uncollectible

◦easy to apply◦entry

Bad Debts Expense X Accounts Receivable X

ACCT-3030 6

3. A/R – Bad DebtsAllowance method

◦requires YE adjusting entry◦can be based on

percentage of sales or percentage of receivables

◦accounts in the entries are same with either method the methods only affect the amounts for

the entriesACCT-3030 7

3. A/R – Bad DebtsAllowance method

◦ YE adjusting entry

Bad Debts Expense X Allowance for Uncollectibles X

◦ entry to write off specific A/R

Allowance for Uncollectibles X Accounts Receivable X

entry does not create an expense entry does not change net receivables

ACCT-3030 8

3. A/R – Bad DebtsExamples

◦BE 7-4◦BE 7-5

Collection of previously written-off A/R◦reinstate account balance◦record collection as normal

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4. Other Valuation AllowancesDiscounts

◦YE adjustment needed to estimate amount of outstanding transactions with possible discounts or returns

◦e.g., entry for estimated returns

Sales Returns and AllowancesX Allowance for Returned Merchandise X

ACCT-3030 10

4. Other Valuation AllowancesDiscounts

◦trade reduction off list price used to determine

sales price not recognized in books

◦cash discount for prompt payment e.g., 2/10, n/30 can be accounted for by gross or net

methods ACCT-3030 11

4. Other Valuation AllowancesExample – cash disc net and gross

methodsMake all entries under: (a) gross method

(b) net method

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Date

Oct. 1 Sell $1,000 of merchandise to customer, 2/10, n/30

Oct. 7 Customer returns $100 of merchandise

Oct. 10 Customer pays in full

Assume Oct. 10 payment did not occur

Oct. 27 Customer pays in full

5. Pledging, Assigning, & Factoring A/RReasons

◦obtain cash now rather than wait for collection◦obtain relief from burden of carrying

receivablesCan be accomplished by

◦secured borrowing pledge receivables as collateral for a loan

◦sale of receivables with recourse (seller still has risks of collection) without recourse (purchaser assumes risks)

ACCT-3030 13

5. Pledging, Assigning, & Factoring A/RSecured borrowing on receivablesA borrowing type arrangement

◦can be general receivables pledged as collateral for loan (all receivables or certain dollar amount)

◦can be specific receivables pledged as collateral for loan (then must identify receivables pledged)

Company continues to collect A/RBank usually

◦charges a finance charge against receivables◦charges interest on the loan

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5. Pledging, Assigning, & Factoring A/RExample – Secured Borrowing

◦You pledge all your receivables as collateral for a bank loan. The balance of A/R is $75,000 and bank loan amount is $50,000. The bank charges a 1% fee on the receivables and interest on the loan is 10%.

Record the entries for this transaction.

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5. Pledging, Assigning, & Factoring A/R

ACCT-3030 16

Date Accounts Dr. Cr.

1/1/year 1 Cash 49,250

Interest Expense (75,000 x .01) 750

Notes Payable 50,000

You collect $45,000 of A/R on 3/31/year 1

3/31/year 1

Cash 45,000

A/R 45,00


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You remit collections to bank plus interest on loan.

3/31/year 1

Interest Expense (50,000 x .1 x 1/4) 1,250

Notes Payable 45,000

Cash 46,250

You collect remainder of A/R on 6/30/year 1

6/30/year 1

Cash 30,000

A/R 30,000


ACCT-3030 18


You pay remainder of loan to bank plus interest on loan.

6/30/year 1

Interest Expense (5,000 x .1 x 1/4) 125

Notes Payable 5,000

Cash 5,125

5. Pledging, Assigning, & Factoring A/RSelling (factoring) receivables

◦ usually for all receivables◦ usually continuous arrangement◦ fee usually 1% - 3%◦ usually a holdback (for returns and allowances)

Factoring without recourse◦ a sale and record loss

Factoring with recourse◦ a sale, but follows financial components approach◦ must assign a liability to the recourse provision to

compute the lossACCT-3030 19

5. Pledging, Assigning, & Factoring A/RExample

◦A company factors its A/R balance of $40,000 with a factoring fee of 2% and a 10% holdback.

Record the entries if the transaction is(a) without recourse(b) with recourse

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5. Pledging, Assigning, & Factoring A/R(a) without recourse

ACCT-3030 21

Accounts Dr. Cr.

Cash 35,200

Receivable from Factor (40,000 x .1) 4,000

Loss on Sale of A/R (40,000 x .02) 800

A/R 40,000

5. Pledging, Assigning, & Factoring A/R(b) with recourse; assume the recourse obligation has a fair valued of $2,000Compute net proceeds: Cash received $35,200 Add: Holdback 4,000 $39,200 Less: Recourse obligation 2,000

Net Proceeds $37,200

Compute Loss on Sale: BV of A/R $40,000 Net Proceeds 37,200 Loss on Sale $ 2,800

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5. Pledging, Assigning, & Factoring A/R(b) With recourse

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Accounts Dr. Cr.

Cash 35,200

Due From Factor 4,000

Loss on Sale of A/R 2,800

A/R 40,000

Recourse Liability 2,000

6. Notes Receivable Recognition of N/R

◦ short-term N/R recorded at face value

◦ long-term N/R recorded at PV of future cash flows

Notes can be received for◦ loaning money

◦ selling goods or services

Notes can have a stated interest rate or no interest rate◦ Stated interest rate on N/R can be

equal to market rate, greater than market rate, or less than market rate

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6. Notes ReceivableInterest-bearing notes

ExampleYou received a $1,000, two year, 6% note receivable in exchange for merchandise.

Make entries to record this transactions if the market interest rate is:

(a) 6%

(b) 8%ACCT-3030 25

6. Notes Receivable(a) market interest rate is 6%

PV of 2 year, 6%, $1,000 note discounted at 6% =

1,000 (n=2, i=6, PMT=60, FV=1000, CPT PVA-ord)

PV of interest payments

PVA-ord(2, 6%) = 60 x 1.83339 = 110

PV of principle paymentPV = 1,000 x .89000 = 890

1,000ACCT-3030 26

6. Notes Receivable(a) market interest rate is 6%

ACCT-3030 27


1/1/year 1

Notes Receivable 1,000

Sales 1,000

12/31/year 1

Cash 60

Interest Revenue 60

12/31/year2

Cash 60

Interest Revenue 60

12/31/year2

Cash 1,000


6. Notes Receivable(b) market interest rate is 8%

PV of 2 year, 6%, $1,000 note discounted at 8% = 964

(n=2, i=8, PMT=60, FV=1000, CPT PVA-ord)

PV of interest payments

PVA-ord(2, 8%) = 60 x 1.78326 = 107

PV of principle paymentPV = 1,000 x .85734 = 857

964ACCT-3030 28

6. Notes Receivable

ACCT-3030 29


1/1/year 1


Discount on N/R 36

Sales 964

12/31/year 1

Cash 60

Discount on N/R 17

Interest Revenue (964 x .08) 77

12/31/year 2

Cash 60

Discount on N/R 19

Interest Revenue (964 + 17 = 981; 981 x .08 = 79)

79

12/31/year 2

Cash 1,000


6. Notes ReceivableNon-interest-bearing note

◦zero percent interest is unreasonable◦must impute interest rate◦use imputed rate to amortize note◦Also

interest rate in arm’s length transaction is considered reasonable unless zero interest rate clearly unreasonable interest rate face amount of note significantly differs from cash

sales priceACCT-3030 30

6. Notes ReceivableExampleYou accept a $12,500, three year, non-interest-bearing note for the sale of merchandise. The merchandise has a cash price of $10,000.

ACCT-3030 31

6. Notes ReceivableExampleN = 3i = ?PV = $10,000FV = $12,500

i = 7.7%

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6. Notes Receivable

ACCT-3030 33


1/1/year 1 Notes Receivable 12,500

Discount on N/R 2,500

Sales 10,000

12/31/year 1

Discount on N/R 770

Interest Revenue (12500-2500=10000; 10000 x .077 = 770)

770

12/31/year 2

Discount on N/R 829

Interest Revenue (2500 – 770 = 1730; 12500-1730 =10770; 10770 x .077 = 829)

829

12/31/year 3

Discount on N/R 901*

Interest Revenue (1730 – 829 = 901; 12500-901=11599; 11599x .077 ≈ 901)

901*

12/31/year 3

Cash 12,500


* = rounded

7. Fair Value OptionFASB allows financial instruments

to be valued at fair valueIf company chooses fair value

option◦adjust notes to FV at year-end◦unrealized holding gains or losses

included in net incomeOnce elected must always

continue to be usedACCT-3030 34

Chapter 7 Cash and Receivables ACCT-30301. 1. Cash Few problems ◦ easy valuation and...

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Transcript of Chapter 7 Cash and Receivables ACCT-30301. 1. Cash Few problems ◦ easy valuation and...