Transcript Chapter 7
Chapter 7
Cash and Receivables
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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
Illustration 7-2
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2. Accounts and Notes Receivable
Receivables
◦ claims held against customers and others for
money, goods, or services
A/R – oral promises to pay
N/R – written promises to pay
◦ a negotiable instrument
Trade vs. Nontrade receivables
◦ trade – customers
◦ nontrade – officers, stockholders, affiliates,
deposits
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3. A/R – Bad Debts
Bad debts
◦ uncollectible accounts receivable
Two 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
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3. A/R – Bad Debts
Direct write-off method
◦ expense recorded when account deemed
uncollectible
◦ easy to apply
◦ entry
Bad Debts Expense
Accounts Receivable
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3. A/R – Bad Debts
Allowance 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 entries
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3. A/R – Bad Debts
Allowance 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
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3. A/R – Bad Debts
Examples
◦ 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 Allowances
Discounts
◦ YE adjustment needed to estimate amount of
outstanding transactions with possible
discounts or returns
◦ e.g., entry for estimated returns
Sales Returns and Allowances
Allowance for Returned Merchandise
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4. Other Valuation Allowances
Discounts
◦ 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
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4. Other Valuation Allowances
Example – cash disc net and gross methods
Make all entries under: (a) gross method
(b) net method
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
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5. Pledging, Assigning, & Factoring A/R
Reasons
◦ obtain cash now rather than wait for collection
◦ obtain relief from burden of carrying receivables
Can 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)
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5. Pledging, Assigning, & Factoring A/R
Secured borrowing on receivables
A 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/R
Bank usually
◦ charges a finance charge against receivables
◦ charges interest on the loan
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5. Pledging, Assigning, & Factoring A/R
Example – 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
Date
1/1/year 1
Accounts
Cash
Dr.
Cr.
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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5. Pledging, Assigning, & Factoring A/R
Date
Accounts
Dr.
Cr.
You remit collections to bank plus interest on loan.
3/31/year 1
Interest Expense (50,000 x .1 x 1/4)
Notes Payable
1,250
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
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5. Pledging, Assigning, & Factoring A/R
Date
Accounts
Dr.
Cr.
You pay remainder of loan to bank plus interest on loan.
6/30/year 1
Interest Expense (5,000 x .1 x 1/4)
Notes Payable
125
5,000
Cash
5,125
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5. Pledging, Assigning, & Factoring A/R
Selling (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 loss
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5. Pledging, Assigning, & Factoring A/R
Example
◦ 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
Accounts
Dr.
Cash
Cr.
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
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5. Pledging, Assigning, & Factoring A/R
(b) with recourse; assume the recourse
obligation has a fair valued of $2,000
Compute net proceeds:
Cash received
$35,200
Add: Holdback
4,000
Less: Recourse obligation
Net Proceeds
$39,200
2,000
$37,200
Compute Loss on Sale:
BV of A/R
Net Proceeds
Loss on Sale
$40,000
37,200
$ 2,800
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5. Pledging, Assigning, & Factoring A/R
(b) With recourse
Accounts
Dr.
Cash
Cr.
35,200
Due From Factor
4,000
Loss on Sale of A/R
2,800
A/R
40,000
Recourse Liability
2,000
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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 Receivable
Interest-bearing notes
Example
You 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%
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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 payment
PV = 1,000 x .89000
= 890
1,000
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6. Notes Receivable
(a) market interest rate is 6%
Date
1/1/year 1
Accounts
Notes Receivable
Dr.
1,000
Sales
12/31/year 1
1,000
Cash
60
Interest Revenue
12/31/year2
60
Cash
60
Interest Revenue
12/31/year2
Cr.
60
Cash
1,000
Notes Receivable
1,000
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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 payment
PV = 1,000 x .85734
= 857
964
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6. Notes Receivable
Date
1/1/year 1
Accounts
Notes Receivable
Dr.
1,000
Discount on N/R
36
Sales
12/31/year 1
964
Cash
60
Discount on N/R
17
Interest Revenue (964 x .08)
12/31/year 2
77
Cash
60
Discount on N/R
19
Interest Revenue (964 + 17 = 981; 981 x .08 = 79)
12/31/year 2
Cr.
Cash
79
1,000
Notes Receivable
1,000
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6. Notes Receivable
Non-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 price
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6. Notes Receivable
Example
You accept a $12,500, three year, noninterest-bearing note for the sale of
merchandise. The merchandise has a cash
price of $10,000.
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6. Notes Receivable
Example
N =3
i =?
PV = $10,000
FV = $12,500
i
= 7.7%
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Date
Accounts
6. Notes
Receivable
Notes Receivable
1/1/year 1
Dr.
12,500
Discount on N/R
2,500
Sales
12/31/year 1
10,000
Discount on N/R
770
Interest Revenue (12500-2500=10000;
10000 x .077 = 770)
12/31/year 2
Discount on N/R
770
829
Interest Revenue (2500 – 770 = 1730;
12500-1730 =10770; 10770 x .077 = 829)
12/31/year 3
Discount on N/R
829
901*
Interest Revenue (1730 – 829 = 901;
901*
12500-901=11599; 11599x .077 ≈ 901)
12/31/year 3
Cr.
Cash
*=
rounded
12,500
Notes Receivable
12,500
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7. Fair Value Option
FASB allows financial instruments to be
valued at fair value
If company chooses fair value option
◦ adjust notes to FV at year-end
◦ unrealized holding gains or losses included in
net income
Once elected must always continue to be
used
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