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Chapter 7

Chapter 7. Cash and Receivables. 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

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Chapter 7

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  1. Chapter 7 Cash and Receivables

  2. 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

  3. 1. Cash Illustration 7-2

  4. 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

  5. 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

  6. 3. A/R – Bad Debts • Direct write-off method • expense recorded when account deemed uncollectible • easy to apply • entry Bad Debts Expense X Accounts Receivable X

  7. 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

  8. 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

  9. 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

  10. 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 X Allowance for Returned Merchandise X

  11. 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

  12. 4. Other Valuation Allowances • Example – cash disc net and gross methods Make all entries under: (a) gross method (b) net method

  13. 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)

  14. 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

  15. 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.

  16. 5. Pledging, Assigning, & Factoring A/R

  17. 5. Pledging, Assigning, & Factoring A/R

  18. 5. Pledging, Assigning, & Factoring A/R

  19. 5. Pledging, Assigning, & Factoring A/R • Selling (factoring) receivables • usually for all receivables • usually continuous arrangement • fee usually 1% - 3% • usually a holdback • 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

  20. 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

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

  22. 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 $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

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

  24. 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, orless than market rate

  25. 6. Notes Receivable • Interest-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%

  26. 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 paymentsPVA-ord(2, 6%) = 60 x 1.83339 = 110PV of principle paymentPV = 1,000 x .89000 = 890 1,000

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

  28. 6. Notes Receivable • 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 paymentsPVA-ord(2, 8%) = 60 x 1.78326 = 107PV of principle paymentPV = 1,000 x .85734 = 857 964

  29. 6. Notes Receivable

  30. 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

  31. 6. Notes Receivable ExampleYou accept a $12,500, three year, non-interest-bearing note for the sale of merchandise. The merchandise has a cash price of $10,000. The current market interest rate is 5%.

  32. 6. Notes Receivable • ExampleN = 3 i = ? PV = $10,000 FV = $12,500i= 7.7%

  33. 6. Notes Receivable * = rounded

  34. 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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