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Chapter 6 – Time Value of Money
• Tell me what you did for partial credit– PV– FV– Pmt– n– i
• Solve using– Formulas – Have at it– Tables – Bring your own copies– Calculators – See syllabus for models and also refer
to the “tutorials” linked to on the website
CHAPTER 7
CASH AND RECEIVABLES
Sommers – Intermediate I
Company writes a check for more than the amount in its cash account.
Bank Overdrafts
Generally reported as a current liability.
Offset against other cash accounts only when accounts
are with the same bank.
Reporting Cash
Written promises to pay a sum of money on a specified future date.
Receivables - Claims held against customers and others for money, goods, or services.
Oral promises of the purchaser to pay for goods and services sold.
Accounts ReceivableAccounts Receivable Notes ReceivableNotes Receivable
Accounts Receivable
Nontrade Receivables
1. Advances to officers and employees.
2. Advances to subsidiaries.
3. Deposits to cover potential damages or losses.
4. Deposits as a guarantee of performance or payment.
5. Dividends and interest receivable.
6. Claims against: 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.).
Accounts Receivable
Reductions from the list price
Not recognized in the accounting
records
Customers are billed net of discounts
Trade Discounts
Inducements for
prompt payment
Gross Method
vs. Net MethodPayment terms are 2/10, n/30
Cash (Sales) Discounts
Big Customers Are Slow to Pay – WSJ Jun 7, 2012
Sales and Trade Discounts
Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30.
Assume the gross method of accounting for cash discounts is used.
Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.
Sales and Trade Discounts
Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30.
Assume the gross method of accounting for cash discounts is used.
Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.
Sales and Trade Discounts
Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30.
Assume the net method of accounting for cash discounts is used.
Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.
Sales and Trade Discounts
Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30.
Assume the net method of accounting for cash discounts is used.
Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.
A company should measure receivables in terms of their present value.
In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period.
Non-Recognition of Interest
How are these accounts presented on the Balance Sheet?
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 500 25 End.
Recognition of A/R
Current Assets:
Cash 346$
Accounts receivable 500
Less: Allowance for doubtful accounts (25) 475
Inventory 812
Prepaids 40
Total current assets 1,673
Fixed Assets:
Office equipment 5,679
Furniture & fixtures 6,600
Less: Accumulated depreciation (3,735)
Total fixed assets 8,544 Total Assets 10,217$
Assets
Recognition of A/R
Current Assets:
Cash 346$
Accounts receivable, net of $25 allowance 475
Inventory 812
Prepaids 40
Total current assets 1,673
Fixed Assets:
Office equipment 5,679
Furniture & fixtures 6,600
Less: Accumulated depreciation (3,735)
Total fixed assets 8,544 Total Assets 10,217$
Assets
Recognition of A/R
An uncollectible account receivable is a loss of revenue
that requires, through proper entry in the accounts,
a decrease in the asset accounts receivable and
a related decrease in income and stockholders’
equity.
Uncollectible A/R
Allowance Method
Losses are Estimated:
Percentage-of-sales.
Percentage-of-receivables.
GAAP requires when material in amount.
Methods of Accounting for Uncollectible Accounts
Direct Write-Off
Theoretically deficient:
No matching.
Receivable not stated at cash realizable value.
Not GAAP when material in amount.
Direct Write-Off vs. Allowance Method
Emphasis on the Income Statement relationships
Emphasis on the Income Statement relationships
Emphasis on the Balance Sheet relationships
Emphasis on the Balance Sheet relationships
Percentage of Sales vs. Receivables
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.
Percentage of Sales Approach
Example 1a
West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year:• Accounts receivable $ 900,000• Allowance for bad debts (credit balance) 16,000• Credit sales for 2009 1,750,000
West uses the following method of estimating bad debts for 2009:• Based on 2% of credit sales.
What amount should West charge to bad debt expense at the end of 2009 under Percentage of Sales (income statement) method?
Percentage-of-Receivables Approach
Not matching.
Reports receivables at realizable value.
Companies may apply this method using
one composite rate, or
an aging schedule using different rates.
Percentage-of-Receivables Approach
Example 1b
West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year:• Accounts receivable $ 900,000• Allowance for bad debts (credit balance) 16,000• Credit sales for 2009 1,750,000
West uses the following method of estimating bad debts for 2009:• Based on 5% of year-end accounts receivable.
What amount should West charge to bad debt expense at the end of 2009 under Percentage of Accounts Receivable (balance sheet) method?
What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?
A/R Aging Adjustment
Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows:
Beginning balance $ 574,000
Credit sales 2,620,000
Collections (2,483,000)
Write-offs (68,000)
Ending balance $ 643,000
The company’s controller prepared the following aging summary of year-end accounts receivable:Age Group Amount % Uncollectible
0-60 days $430,000 4%
61-90 days 98,000 15%
91-120 days 60,000 25%
Over 120 days 55,000 40%
Totals $643,000
Prepare a summary journal entry to record the monthly bad debt accrual and the write-offs during the year.
Bad Debt ProblemDuring the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. Accounts receivable activity for 2011 was as follows:
Beginning balance $ 574,000
Credit sales 2,620,000
Collections (2,483,000)
Write-offs (68,000)
Ending balance $ 643,000
Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows:
Beginning balance $ 574,000
Credit sales 2,620,000
Collections (2,483,000)
Write-offs (68,000)
Ending balance $ 643,000
The company’s controller prepared the following aging summary of year-end accounts receivable: Age Group Amount % Uncollectible
0-60 days $430,000 4%
61-90 days 98,000 15%
91-120 days 60,000 25%
Over 120 days 55,000 40%
Totals $643,000
Prepare the necessary year-end adjusting entry for bad debt expense.
Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000.
Age Group Amount % Uncollectible Allowance
0-60 days $430,000 4% $17,200
61-90 days 98,000 15% 14,700
91-120 days 60,000 25% 15,000
Over 120 days 55,000 40% 22,000
$68,900
ABD
Bad Debt Problem
What is total bad debt expense for 2011?
How would accounts receivable appear in the 2011 balance sheet?
Sandel Company reports the following financial information before adjustments.
Prepare the journal entry to record bad debt expense assuming
Sandel estimates bad debts at (a) 1% of net sales.
Example 2a
Sandel Company reports the following financial information before adjustments.
Prepare the journal entry to record bad debt expense assuming
Sandel estimates bad debts at (b) 5% of accounts receivable.
Example 2b
Effect of Write-Offs
On May 6, Timberland wrote off a specific account receivable with balance of $2,500.
Assume that before the write-off entry, Timberland’s Accounts Receivable balance was $81,000,000 and the Allowance for Doubtful Accounts balance was $2,000,000. What effect did the write-off have?
Date Description Debit CreditMay 6 Allowance for Doubtful Accounts 2,500
Accounts Receivable 2,500
Before Write-Off
After Write-Off
Accounts receivable 81,000,000$ 80,997,500$ Less: Allow. for doubtful accts. 2,000,000 1,997,500 Net realizable value 79,000,000$ 79,000,000$
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:
Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries:
LO 5
Reversal of Write-Off
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).
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).
Notes Receivable..
Note Receivable Journal Entries
On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation.
Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold).
June 30, 2011
Note Receivable Journal Entries
On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation.
Prepare the journal entry at December 31, 2011.
December 31, 2011
Note Receivable Journal Entries
On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation.
Prepare the journal entry at March 31, 2012.
March 31, 2012
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?
0 1 2 3
1,000 1,000 Interest$1,000
$10,000 Principal
4
i = 12%
n = 3
Interest-bearing Note
FV=10,000, pmt=1,000, n=3, i=12% => PV=9,520
Illustration: How does Morgan record the receipt of the note?
Interest-bearing Note
Illustration 7-15
Interest-bearing Note
Journal Entries for Interest-Bearing Note
Date Account Title Debit Credit
Beg. yr. 1 Notes receivable 10,000
Discount on notes receivable 480
Cash 9,520
End. yr. 1
($9,520 x 12%)
Interest-bearing Note
Q7-15 What is “imputed interest”?
In what situations is it necessary to impute an interest rate for notes receivable?
Discussion Question
Discussion Question
Q7-15 Continued – What are the considerations in imputing an appropriate rate?
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold).
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
Prepare the amortization schedule.
Cash Interest Amort Balance4/30/2011 29,890 4/30/2012 4/30/2013 4/30/2014 4/30/2015 4/30/2016
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
Prepare the journal entry at December 31, 2011.
December 31, 2011
Cash Interest Amort Balance4/30/2011 29,890
4/30/2012 -
1,793 1,793 31,683
4/30/2013 -
1,901 1,901 33,584
4/30/2014 -
2,015 2,015 35,599
4/30/2015 -
2,136 2,136 37,735
4/30/2016 -
2,265 2,265 40,000
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
Prepare the journal entry at December 31, 2012.
December 31, 2012
Cash Interest Amort Balance4/30/2011 29,890
4/30/2012 -
1,793 1,793 31,683
4/30/2013 -
1,901 1,901 33,584
4/30/2014 -
2,015 2,015 35,599
4/30/2015 -
2,136 2,136 37,735
4/30/2016 -
2,265 2,265 40,000
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
What is the balance of the note at December 31, 2012?
Cash Interest Amort Balance4/30/2011 29,890
4/30/2012 -
1,793 1,793 31,683
4/30/2013 -
1,901 1,901 33,584
4/30/2014 -
2,015 2,015 35,599
4/30/2015 -
2,136 2,136 37,735
4/30/2016 -
2,265 2,265 40,000
Non-Interest Bearing Note
On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.
Prepare the journal entry at April 30, 2016.
April 30, 2016
Cash Interest Amort Balance4/30/2011 29,890
4/30/2012 -
1,793 1,793 31,683
4/30/2015 -
2,136 2,136 37,735
4/30/2016 -
2,265 2,265 40,000
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.
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:
Notes Receivable Example
Discussion Question
Q7-16 What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?
Short-Term reported at Net Realizable Value (same as
accounting for accounts receivable).
Long-Term - FASB requires companies disclose not only
their cost but also their fair value in the notes to the
financial statements.
► Fair Value Option. Companies have the option to use
fair value as the basis of measurement in the financial
statements. Adjustments to value go through net income.
Valuation of Notes Receivable
Owner may transfer accounts or notes 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. Sale of receivables
Disposition of Receivables
Disposition of Receivables
Secured borrowing• Now
Cash XXX
Payable XXX
Get cash sooner, have A/R and payable on books
• Later
Cash XXX
A/R XXX
Payable XXX
Cash XXX
Sale of Receivables• Now
Cash XXX
A/R XXX
Get cash sooner, but have nothing else on books
• Later
Nothing
The FASB
concluded that a
sale occurs only if
the seller surrenders
control of the
receivables to the
buyer.
Three conditions
must be met.
Secured borrowing vs. Sale
Factors are finance companies or banks that buy receivables from businesses for a fee.
Illustration 7-17
Sale of Receivables
Sale Without Recourse
Purchaser assumes risk of collection Transfer is outright sale of receivable Seller records loss on sale Seller uses Due from Factor (receivable) account to
cover discounts, returns, and allowances
Sale With Recourse Seller guarantees payment to purchaser Financial components approach used to record transfer
Sale of Receivables
1. Segregate the different types of receivables that a company
possesses, if material.
2. Appropriately offset the valuation accounts against the proper
receivable accounts.
3. Determine that receivables classified in the current assets
section will be converted into cash within the year or the
operating cycle, whichever is longer.
4. Disclose any loss contingencies that exist on the receivables.
5. Disclose any receivables designated or pledged as collateral.
6. Disclose the nature of credit risk inherent in the receivables.
Presentation of Receivables
Discussion Question
Q7-21 What is the accounts receivable turnover ratio, and what type of information does it provide?
This Ratio used to:
Assess the liquidity of the receivables.
Measure the number of times, on average, a company
collects receivables during the period.
A/R Turnover Ratio
RELEVANT FACTS - Similarities
The accounting and reporting related to cash is essentially the same under both IFRS and GAAP. In addition, the definition used for cash equivalents is the same.
Like GAAP, cash and receivables are generally reported in the current assets section of the balance sheet under IFRS.
Similar to GAAP, IFRS requires that loans and receivables be accounted for at amortized cost, adjusted for allowances for doubtful accounts.
IFRS
RELEVANT FACTS - Differences
Under IFRS, companies may report cash and receivables as the last items in current assets under IFRS. Under GAAP, these items are reported in order of liquidity.
While IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. GAAP has explicit guidance in the area.
The fair value option is similar under GAAP and IFRS 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
RELEVANT FACTS - Differences
Under IFRS, bank overdrafts are generally reported as cash. Under GAAP, such balances are reported as liabilities.
IFRS and GAAP differ in the criteria used to account for transfers of receivables. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS generally permits partial transfers; GAAP does not.
IFRS
