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CH07
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Chapter 7
Cash and Receivables
1
Preview of Chapter 7
2
Cash
Receivables
Cash Discounts (Gross and Net method)
Uncollectible accounts (Aging method vs % of Sales)
Recognition and Measurement of Short-Term/Long-Term Notes and Loans Receivable
Derecognition of Receivables
Secured borrowings
Sales of Receivables
3
What is Cash?
Ex: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashiers checks, personal checks, bank drafts and savings accounts.
Cash is reported as a current asset if it is readily available
to pay current obligations and is free of restrictions
Special reporting is needed for :
1. Restricted cash
2. Cash in foreign currencies
3. Bank overdrafts
4. Cash equivalents
4
Restricted Cash
Companies must segregate restricted cash from regular cash for reporting purposes if the amount is material. Ex, cash restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances.
Classified as current assets if they relate to short-term loans
Classified as non-current assets if set aside for investment or financing purposes (e.g. plant expansion)
Compensating balances: minimum cash balances maintained by a corporation in support of existing borrowings not available for use by the corporation.
Note disclosure of restricted cash is required
5
Foreign Currencies
Amount held in foreign currencies is reported in Canadian dollars at the balance sheet date
The exchange rate on the balance sheet date is used to translate foreign currencies into Canadian dollars
If restrictions exist on the foreign funds, those funds are reported as restricted
6
Bank Overdrafts
When a company writes a check for more than the amount in its cash account.
Overdrafts are reported as current liabilities (often
reported as accounts payable)
In general, bank overdrafts should not be offset
against the Cash account
However, bank overdrafts may be offset against
available cash in another account if both accounts are
at the same bank
7
Cash Equivalents Short-term, highly liquid investments that are readily
convertible to known amounts of cashsubject to an insignificant risk of change in value.
Original maturity is generally three months or less
Examples: treasury bills, money-market funds, commercial paper
Cash equivalents are reported at fair value
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Receivables
Claims against customers and other parties for money,
goods, or services
Receivables are classified as either current (short-term)
or noncurrent (long-term)
Classified as current receivables if there is the
expectation to collect within one year or operating
cycle (whichever is longer)
Receivables can be classified as either trade receivables
or nontrade receivables
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Accounts Receivable
Trade receivables include:
Accounts receivable (verbal promise to pay, normally
within 30 to 60 days)
Notes receivable (written promises with specified
terms, e.g. interest rate and due date)
Nontrade receivables include the following:
1. Advances to employees or other officers
2. Receivables from the government (e.g. GST recoverable, income
tax receivable)
3. Dividends and interest receivable
4. Amounts owing by insurance companies
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Accounts Receivable: Trade Discounts
vs. Cash Discounts
Trade discounts are discounts given to customers often for different quantities purchased (often quoted as a percentage)
Trade discounts are generally not recorded; the price charged (net of the discount) is recorded by the seller as a receivable and revenue
Cash discounts (or sales discounts) encourage customers to pay faster; they are recorded
2/10, n/30; the customer will receive a 2% discount if payment made within 10 days otherwise the gross amount of the invoice is due in 30 days
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Accounts Receivable: Recording Cash
Discounts
Two methods: gross method and net method
Gross method records discounts when customers pay within discount period
Sales Discounts are deducted from sales on the income statement
Most common method
Net method records accounts receivable net of the discount; discounts forfeited by customers are recorded when not taken
Preferred method but rarely used
Sales Discounts Forfeited is recorded as Other revenue if customer does not take the discount
Cash Discounts
Gross Method/Net Method Example
July 1 sold $82,000 of computers to Robertson Corp., terms
2/15, n/30
July 5 Robertson Corp. returned for full credit one computer
with an invoice price of $6,200
July 10 - Salini received payment from Robertson for the full
amount owed from the July transactions
July 17 - Sold $160,000 in computers and peripherals to
Clarkson Store, terms 2/10, n/30
July 26 Clarkson Store paid Salini for half of its July purchases
Aug. 30 Clarkson Store paid Salini for the remaining half of its
July purchases.
1. Prepare j/es for Salini assuming the Gross Method
2. Prepare j/es for Salini assuming the Net Method
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Measurement of Accounts Receivable
Short-term receivables are reported at their net realizable value (NRV)
The NRV is the net amount of cash expected to be collected
Calculated as: Gross accounts receivable less estimated uncollectible
accounts and any returns, allowances, or cash discounts
Loans and receivables impaired if there is significant adverse change in
expected timing or amount of cash flows
15
Estimating Uncollectible Accounts
Receivables are reported net of an Allowance for Doubtful Accounts
The estimate of uncollectible accounts may be based on:
Aging method (or % of Receivables) - management frequently estimates uncollectible amounts and adjusts the Allowance for Doubtful Accounts
Mix of Procedures - % of Sales during the year, and Aging method at the end of the year.
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Balance Sheet Presentation
Short-term accounts receivable are shown at their net
realizable value as follows:
Accounts Receivable $ xxx
Less: Allow. for Doubtful Accounts xxx
Net Accounts Receivable $ xxx
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Allowance Method: Writing Off Accounts
Receivable
When a specific customers account is determined to be uncollectible, the following entry is made:
Dr. Allowance for Doubtful Accounts x
Cr. Accounts Receivable specific customer x
(for the amount to be written off)
If payment is received after write-off of account,
the account is reinstated and payment is recorded:
Dr. Accounts Receivable
Cr. Allowance for Doubtful
Accounts
Dr. Cash
Cr. Accounts Receivable
(for the amount collected)
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Direct Write-off Method
If uncollectible amounts are not material, the
allowance method is not required and direct write-off
method can be used
Record bad debt expense only when specific account
is determined to be uncollectible:
Dr. Bad Debt Expense xx
Cr. Accounts Receivable xx
No allowance account is used
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Short-Term Notes Receivable
Notes receivable differ from accounts receivable as they
are supported by a promissory note
All notes contain some interest
Notes are either Interest bearing or Zero-interest bearing
(Interest amount is the difference between the amount
borrowed and the face amount).
20
Interest Bearing Short-Term Notes
Receivable
Example: On March 14, 2011, Accounts Receivable of $1,000 is
exchanged for a 6% six-month note.
What is j/e recorded on March 14th?
What is the j/e recorded on September 14th when collection is made?
21
Non-Interest Bearing
Short-Term Notes Receivable
On February 23, 2011, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate
What' j/e is recorded Feb 23rd?
What j/e is recorded Nov. 23rd when the note is collected?
22
Long-term Loans Receivable
Long-term loans receivable are recognized at fair
value (present value of the future cash flows)
When the stated interest rate is the same as the market
interest rate, the note or loan is issued at its face value
When there is a difference between interest rates, the note
or loan is issued at a premium or a discount (i.e. the
present value is greater or less than the face value)
23
Long-term Loans Receivable Interest Bearing Notes
Example: Morgan Corp. issues a $10,000, 10% three-year note; market interest rate is 12% and annual interest payments are $1,000 (10% x $10,000)
In calculating the notes present value, use 12% market rate to discount all future cash flows as follows:
($10,000 x .71178) + ($1,000 x 2.40183) = $9,520
The note is issued at a discount (as proceeds < face)
Journal Entry at issuance of note: Dr. Notes Receivable 9,520
Cr. Cash 9,520
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Long-term Loans Receivable Interest Bearing Notes
Example continued:
At date of issue, the company has an unamortized
discount of $480 (to be amortized over the 3 years)
The discount represents interest income to be
recognized over the 3 year life of the note
$9,520 x 12% = $1,142 (first year interest income)
Journal Entry to record first $1,000 interest received: Dr. Cash 1,000 Dr. Notes Receivable 142
Cr. Interest Income 1,142
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Long-term Loans Receivable Interest Bearing Notes
Example continued:
Book value of Notes Receivable is now:
$10,000 ($480 - $142) = $9,662
Interest Income for second year:
$9,662 12% = $1,159
Journal Entry to record second $1,000 interest received: Dr. Cash 1,000 Dr. Notes Receivable 159 Cr. Interest Income 1,159
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Long-term Loans Receivable Interest Bearing Notes
Example continued:
Under straight-line method (as opposed to the
effective interest rate method), initial discount of $480
is recognized as interest income evenly over 3 years at
$480 / 3 years = $160 per year
IFRS requires the use of effective interest method of
amortization
Private entity GAAP does not specify the amortization
method
E 7-14
Option 1: One-year note for $105,000 due Sept. 30, 2011.
Interest of 8% is payable at maturity
Option 2: One-year non-interest bearing note for
$113,400. Implied interest rate is 8%.
a) Assume Option 1: prepare j/es required on Big Corps
books(the lender) Sept 30, 2010, December 31, 2010, and
September 30, 2011.
b) Assume Option 2: prepare j/es required on Big Corps books
Sept 30, 2010, December 31, 2010, and September 30, 2011.
27
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The holder of accounts or notes receivable may transfer to another company for cash
The transfer may be:
A secured borrowing (Holder retains ownership)
A sale of receivables (Holder transfers ownership)
Derecognition of Receivable
29
Borrowing vs. Sale Treatment
Conditions
1. Are transferred assets isolated
from transferor? and
2. Does transferee have right to
pledge or sell the assets? and
3. Transferor does not maintain
control of the assets through
repurchase agreement?
Yes Sale
Secured
Borrowing
No
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Accounting for Transfers
of Receivables
Secured Borrowing Sale
Transfers
Continuing
involvement by seller
No continuing
involvement by seller
Use components approach:
1. Reduce receivables,
2. Recognize component
assets and liabilities,
3. Record gain/loss
1. Reduce receivables,
2. Record gain/loss
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Sale of Receivables (e.g., Factoring)
Ownership of receivables transferred to the purchaser
(the factor); receivables recorded as an asset in the
purchasers books
If sold without recourse, purchaser is fully responsible
for collections of the receivables
Seller records any retained proceeds as due from
factor (a receivable) which covers possible sales
discounts and sales returns and allowances
Seller records gain/loss on sale of receivables (normally
a loss, representing the finance charge)
Seller records any recourse liability (if receivables are
sold with recourse i.e., sellers guarantee)
E 7-19
Chessman Corp factors $600,000 of A/R with Liquidity
Financing on a with recourse basis. Liquidity Financing will
collect the receivables. The receivable records are
transferred to Liquidity Financing on August 15, 2010.
Liquidity Financing assesses a finance charge of 2.5% of the
amount of A/R and also reserves an amount equal to 5.25%
of A/R to cover probable adjustments.
1. Prepare the j/e on August 15, 2010 for Chessman to
record the sale of receivables, assuming the recourse
obligation has a fair value of $6,000.
2. What effect will the factoring of receivables have on
A/R turnover for Chessman?
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