1 the revenue/ receivable/cash cycle chapter chapter 7 an electronic presentation by douglas cloud...
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The Revenue/The Revenue/ Receivable/CasReceivable/Cas
h Cycleh Cycle
chapterchapter 7
An electronic presentationAn electronic presentation by Douglas Cloudby Douglas Cloud
Pepperdine UniversityPepperdine University
An electronic presentationAn electronic presentation by Douglas Cloudby Douglas Cloud
Pepperdine UniversityPepperdine University
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1. Explain the normal operating cycle of a business.
2. Prepare journal entries to record sales revenue, including the accounting for bad debts and warranties for service or replacement.
3. Analyze accounts receivable to measure how efficiently a firm is using this operating asset.
Learning Objectives
ContinuedContinuedContinuedContinued
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4. Discuss the composition, management, and control of cash, including the use of a bank reconciliation.
5. Recognize appropriate disclosures for presenting sales and receivables in the financial statements.
Learning Objectives
ContinuedContinuedContinuedContinued
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Learning Objectives
6. Explain how receivables may be used as a source of cash through secured borrowing or sale.
7. Describe proper accounting and valuation of notes receivable
8. Understand the impact of uncollectible accounts on the statement of cash flows.
EXPANDED LEARNING OBEJCTIVES:
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5Revenue/Receivables/Cash Timeline
DELIVER a product or
service
COLLECT cash
(includes discounts)
RETURNSRETURNS
ACCEPT returned products
STRUGGLEwith
nonpaying customers
PROVIDEcontinuing
services
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6The Operating Cycle of a Business
CashCash
AccountsReceivables
Inventory
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Assume that Acme Manufacturing sold merchandise to Harper Company on account.
The Operating Cycle of a Business
When the collection takes place: Cash 1,000
Accounts Receivable 1,000Payment received on account.
When the inventory is sold on account:Accounts Receivable 1,000
Sales 1,000 Sold merchandise to HarperCompany on account.
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• Trade receivables: Receivables arising from normal operating activities.
• Notes receivable: Trade receivables evidenced by a formal written promise to pay.
• Nontrade receivables: All receivables arising from activities other than normal operations.
Receivables are all claims against other entities. They are usually settled in cash.
The Operating Cycle of a Business
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9The Operating Cycle of a Business
Nontrade receivables arise from a variety of transactions, such as—
(1) The sale of securities or property other than inventory
(2) Deposits to guarantee contract performance or expense payments
(3) Claims for rebates and tax refunds
(4) Dividends and interest receivable
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Accounting for Sales Revenues
A trade discount may
vary by customer,
depending on the volume of
business or size or order.
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Accounting for Sales Revenues
A cash (sales) discount is offered to
customers to encourage
prompt payment of bills.
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Assume on March 15, $1,000 of merchandise is sold on account. The terms of the agreement are 2/10, n/30. The firm uses the gross method for record sales on account.
Accounting for Sales Revenues
Entry on date of sale:Accounts Receivable 1,000
Sales 1,000
Gross MethodGross MethodGross MethodGross Method
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Accounting for Sales Revenues
If paid within the discount period:Cash 980Sales Discounts 20
Accounts Receivable 1,000If not paid within the discount period:
Cash 1,000Accounts Receivable 1,000
Gross MethodGross MethodGross MethodGross Method
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This time, assume that all sales on account are recording using the net method. Again, the terms of the agreement are 2/10, n/30.
Accounting for Sales Revenues
At the point of sale (March 15):Accounts Receivable 980
Sales 980
Net MethodNet MethodNet MethodNet Method
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Accounting for Sales Revenues
If paid within the discount period:Cash 980
Accounts Receivable 980
If not paid within the discount period:Cash 1,000
Sales Discounts Not Taken 20Accounts Receivable 980
Net MethodNet MethodNet MethodNet Method
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Sales Returns and Allowances
Red sweaters costing $600 are sold for $1,000. When delivered, it was determined that the sweaters should have been green. The customer agrees to keep the merchandise for a $200 reduction in price.
Sales entry:Accounts Receivable 1,000 Sales 1,000
Cost of Goods Sold 600 Inventory 600
Sales allowance entry:Sales Returns and Allowances 200 Accounts Receivable 200
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Sales Returns and Allowances
Sales return entries:Sales Returns and Allowances 1,000 Accounts Receivable 1,000
Inventory 600Cost of Goods Sold 600
Suppose that instead of the allowance, the customer elects to return the sweaters.
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18Sales Discounts and Sales Returns and Allowances
Income Statement
Sales $15,000
Less: Sales discounts $250
Sales returns and allowances 400 (650) Net sales $14,350
Income Statement
Sales $15,000
Less: Sales discounts $250
Sales returns and allowances 400 (650) Net sales $14,350
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Accounting for Bad Debts
Occur when customers do not pay for items or services purchased on credit.
Bad debts are uncollectible accounts receivable.
Bad Debt Expense is reported as a selling or general and administrative expense.
Accounts receivable are reported on the balance sheet at their net realizable value.
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20Accounting for Uncollectible Receivables (Direct Method)
Write Off: Bad Debts Expense 400
Accounts Receivable 400 To write off an
uncollectible account.
This entry is made when the account has been determined uncollectible. The direct
write-off method is used by small businesses because of its simplicity.
This entry is made when the account has been determined uncollectible. The direct
write-off method is used by small businesses because of its simplicity.
Since this determination was made after the period in which the sale takes place, the
matching principle is violated. This method is not accepted under GAAP.
Since this determination was made after the period in which the sale takes place, the
matching principle is violated. This method is not accepted under GAAP.
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21Accounting for Uncollectible Receivables (Allowance Method)
In this method, an estimate of the total uncollectible accounts is made at the end of the period, and an expense is recognized.
Bad Debts Expense 2,000 Allowance for Bad Debts 2,000 To record estimated
uncollectible accounts.
GAAP requires the use of the allowance method.
GAAP requires the use of the allowance method.
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When the account is then determined to be uncollectible, the write-off entry is:
Accounting for Uncollectible Receivables (Allowance Method)
Allowance for Bad Debts 400 Accounts Receivable 400 To write off an uncollectible
account.
Note: Bad Debt Expense is not debited.Note: Bad Debt Expense is not debited.
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23Accounting for Uncollectible Receivables (Allowance Method)
What happens if the written off receivable is later collected? Assume that the customer from Slide 22 pays the $400 written-off debt a month after the write-off.Accounts Receivable 400
Allowance for Bad Debts 400 To reverse the entry made to
write off the account.
Note: Before the payment entry, the debt must be restored.
Note: Before the payment entry, the debt must be restored.
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24Accounting for Uncollectible Receivables (Allowance Method)
Cash 400 Accounts Receivable 400 To record collection of the
account.
What happens if the written off receivable is later collected? Assume that the customer from Slide 22 pays the $400 written-off debt a month after the write-off.
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25Accounting for Uncollectible Receivables (Allowance Method)
(1) Allowance for Doubtful Accounts is a contra-asset account which is subtracted from Accounts Receivable on the balance sheet.
2) The actual write-off entry for $400 does not reduce net receivables, as shown below:
Accts. Receivable $100,000 Accts. Receivable $99,600Less Allowance for Less Allowance for Doubtful Accounts 2,000 Doubtful Accounts 1,600 Net Receivables $ 98,000 Net Receivables $98,000
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26Estimating the Allowance for Uncollectible Accounts
Percentage of credit sales
Percentage of accounts receivable
Aging receivables
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Example: Doubtful Accounts Expense
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit
sales are not collected.
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit
sales are not collected.
Percentage of Credit Sales
What is the entry to record estimated bad debts?What is the entry to record estimated bad debts?
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Example: Doubtful Accounts ExpensePercentage of Credit Sales
Bad Debt Expense 2,000 Allowance for Doubtful Accounts 2,000
To record estimated uncollectible accounts for the year.
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit
sales are not collected.
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $30,500. The allowance for doubtful accounts balance is $350. Historically, 2 percent of the credit
sales are not collected.
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Percentage of Credit Sales
Allowance for Doubtful Accounts
Balance 350Adjusting 2,000Dec. 31, Bal. 2,350
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Example: Doubtful Accounts Expense
The XYZ company had credit sales of $693,000. The current accounts
receivable balance is $50,000. The allowance account balance is $600. Historically, 3 percent of accounts
receivable are not collectible.
The XYZ company had credit sales of $693,000. The current accounts
receivable balance is $50,000. The allowance account balance is $600. Historically, 3 percent of accounts
receivable are not collectible.
Percentage of Accounts Receivable
What is the required adjusting entry to record estimated bad debts?
What is the required adjusting entry to record estimated bad debts?
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($50,000 x .03) – $600
Percentage of Accounts Receivable
Bad Debt Expense 900 Allowance for Doubtful Accounts 900
To record estimated uncollectible accounts for the year.
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Allowance for Doubtful Accounts
Balance 600Adjusting 900Dec. 31, Bal. 1,500
That’s the desired ending
balance.
That’s the desired ending
balance.
Percentage of Accounts Receivable
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Allowance for Doubtful Accounts
Adjusting 1,850Dec. 31, Bal. 1,500
Balance 350What if the allowance
account had a debit balance of $350?
What if the allowance account had a debit balance of $350?
I see! The ending balance must be “forced” to be the
calculated amount.
I see! The ending balance must be “forced” to be the
calculated amount.
Percentage of Accounts Receivable
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Aging Receivables
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $47,550. The allowance for doubtful accounts balance is
$620. The firm ages the accounts to determine the expected uncollectibles.
The ABC company had credit sales of $100,000. The current accounts
receivable balance is $47,550. The allowance for doubtful accounts balance is
$620. The firm ages the accounts to determine the expected uncollectibles.
Remember, because receivables are Remember, because receivables are involved, the amount derived from involved, the amount derived from
aging provides the desired balance of aging provides the desired balance of the allowance account.the allowance account.
Remember, because receivables are Remember, because receivables are involved, the amount derived from involved, the amount derived from
aging provides the desired balance of aging provides the desired balance of the allowance account.the allowance account.
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Aging Receivables
Uncollectible EstimatedAccounts Amount of
Classification Experience Uncollectible(in days) Balance Percentage Accounts
Not yet due $40,000 2% $ 8001-30 past due 3,000 5 15031-60 past due 1,200 10 12061-90 past due 650 20 13091-180 past due 500 30 150
181-365 past due 800 50 400
+365 past due 1,400 1,120
$47,550 $2,870
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Aging Receivables
Bad Debt Expense 2,250 Allowance for Doubtful Accounts 2,250
To record estimated uncollectible accounts for the year.
Required balance $2,870
Current balance (620)
Adjusting entry $2,250
Required balance $2,870
Current balance (620)
Adjusting entry $2,250
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Allowance for Doubtful Accounts
Balance 620Adjusting 2,250Dec. 31, Bal. 2,870
Aging Receivables
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Accounting for Warranties
MJW Video & Sound sells MJW Video & Sound sells compact stereo systems with a compact stereo systems with a
two-year warranty. Past two-year warranty. Past experience indicates that 10% experience indicates that 10%
of all systems will need of all systems will need repairs in the first year and repairs in the first year and 20% will need repairs in the 20% will need repairs in the second year. The average second year. The average
repair cost is $50 per system.repair cost is $50 per system.
MJW Video & Sound sells MJW Video & Sound sells compact stereo systems with a compact stereo systems with a
two-year warranty. Past two-year warranty. Past experience indicates that 10% experience indicates that 10%
of all systems will need of all systems will need repairs in the first year and repairs in the first year and 20% will need repairs in the 20% will need repairs in the second year. The average second year. The average
repair cost is $50 per system.repair cost is $50 per system.
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The number of systems The number of systems sold in 2004 and 2005 was sold in 2004 and 2005 was
5,000 and 6,000, 5,000 and 6,000, respectively. Actual repair respectively. Actual repair costs were $12,500 in 2004 costs were $12,500 in 2004
and $55,000 in 2005.and $55,000 in 2005.
The number of systems The number of systems sold in 2004 and 2005 was sold in 2004 and 2005 was
5,000 and 6,000, 5,000 and 6,000, respectively. Actual repair respectively. Actual repair costs were $12,500 in 2004 costs were $12,500 in 2004
and $55,000 in 2005.and $55,000 in 2005.
Accounting for Warranties
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Warranty Expense 75,000 Estimated Liability Under Warranties 75,000
To record estimated warranty expense based on systems sold.
To record estimated warranty expense:
Accounting for Warranties
2004200420042004
(5,000 x 0.30) x $50
(5,000 x 0.30) x $50
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Estimated Liability Under Warranties12,500 Cash 12,500
To record cost of actual repairwork in 2004.
To record the actual cost of doing repairs:
Accounting for Warranties
2004200420042004
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Warranty Expense 90,000 Estimated Liability Under Warranties 90,000
To record estimated warranty expense based on systems sold.
To record estimated warranty expense:
Accounting for Warranties
2005200520052005
(6000 x 0.30) x $50
(6000 x 0.30) x $50
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Monitoring Accounts Receivable
Average Collection Period: The average number of days that lapse between the time that a sale is made and the time that cash is collected. It is calculated by dividing the average daily sales by the average receivables outstanding.
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WS Corporation had average receivables of $354,250 and average daily sales of $1,650,000. The average collection period can be calculated as follows:
Average Collection Period:
Average receivable $354,250 Average daily sales ($1,650,000/365)
Average collection period = 78 days
Monitoring Accounts Receivable
=
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Accounts receivable turnover is determined by dividing net sales by the average trade accounts receivable outstanding during the year. For WS Corporation, the 2005 turnover is:
Accounts Receivable Turnover:
Net sales $1,650,000 Average net receivables $354.250
Receivables turnover for year = 4.7 times
Monitoring Accounts Receivable
=
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Cash Management and Control
o Undeposited Coins and currency (change funds)
o Demand depositso Petty cash fundso Cashier’s checkso Personal checks
What items are classified as “cash”?What items are classified as “cash”?What items are classified as “cash”?What items are classified as “cash”?
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Composition of Cash
Many companies report investments in very short-
term, interest-earning securities as cash equivalents
in the balance sheet.
Many companies report investments in very short-
term, interest-earning securities as cash equivalents
in the balance sheet.
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Composition of Cash
A credit balance in the cash account is known as a cash
overdraft and should be reported as a current liability.
A credit balance in the cash account is known as a cash
overdraft and should be reported as a current liability.
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Management and Control of Cash
1) Specifically assigned responsibilities for handling cash receipts
2) Separation of handling and recording receipts
3) Daily deposits of all cash received
4) Voucher system to control cash payments
5) Internal audits at irregular intervals
6) Double record of cash—bank and books, with reconciliation performed by someone outside the accounting function
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Bank Reconciliation
A comparison of the bank balance with the book’s balance by means of a
summary is a bank reconciliation.
A comparison of the bank balance with the book’s balance by means of a
summary is a bank reconciliation.
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Bank Reconciliation
Deposits in transit. Outstanding checks. Bank debits for items such as
service charges and NSF checks. Bank credits for items such as the
bank collecting a note for the depositor.
Accounting errors.
Common causes of differences:
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Balance per books............. $2,952.49 Additions to bank balance:Interest earned...............…. 98.50 Error by depositor.........…. 18.00 Total............................ $3,068.99
Deductions from book balance:Service charge.............. $ ( 3.16 ) NSF check.................... (118.94 )Corrected book bal. $2,946.89
Balance per bank.... $2,979.72 Additions to bank balance:Deposits in transit.... 658.50Error by bank 12.50 Total................... $3,650.72
Deductions from bank balance:Outstanding checks: Listed individually (703.83)Corrected bank bal. $2,946.89
Svendsen, Inc.Bank ReconciliationNovember 30, 2005
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All adjustments made to the Balance per Books need to be recorded:
Cash 98.50 Interest Revenue 98.50
To record interest earned.
Cash 18.00Advertising Expense 18.00
To record correction for check inpayment of advertising recordedas $64 instead of the actual amount,$46.
Bank Reconciliation
ContinuedContinuedContinuedContinued
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Accounts Receivable 118.94Miscellaneous General Expense 3.16 Cash 122.10
To record customer’s uncollectible check and bankcharges for November.
Bank Reconciliation
Note:Note: When the item is a plus under When the item is a plus under “Balance per books,” “Balance per books,” CashCash is is debited. When it is a minus, debited. When it is a minus, Cash Cash is credited.is credited.
Note:Note: When the item is a plus under When the item is a plus under “Balance per books,” “Balance per books,” CashCash is is debited. When it is a minus, debited. When it is a minus, Cash Cash is credited.is credited.
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55Presentation of Sales and Receivables in the Financial Statements
Receivables qualifying as current items may be grouped for presentation on the balance sheet in the following classes:
1) Notes receivable—trade debtors
2) Accounts receivable—trade debtors
3) Other receivables
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56Accounts Receivable as aSource of Cash
• As a sale (either with or without recourse.
• As a secured borrowing.
• As a sale (either with or without recourse.
• As a secured borrowing.
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1. The transferred assets have been isolated from the transferor and its creditors cannot access the assets.
2. The transferee has the right to pledge or exchange the transferred assets.
3. The transferor does not maintain effective control over the assets through either (a) an agreement to repurchase them before their maturity or (b) the ability to cause the transferee to return specific assets.
Accounts Receivable as aSource of Cash
SFAS 140 specified conditions that must be met if a transfer of receivables is to be accounted for as a sale:
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Sal
e of
Acc
ount
s R
ecei
vabl
e
Accounts Receivable Established
Goods and Services Provided
Factoring Accounts Receivable
CustomersCustomers CompanyCompany
FactorFactorFactorFactor
Cas
h fr
om F
acto
ring
A
ccou
nts
Rec
eiva
ble
Pay
men
t of
Acc
ount
s R
ecei
vabl
e
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59Accounting for Factoring Accounts Receivable
• Close sold receivables• Close accompanying Allowance for Bad
Debts• Expense any factoring charges• Establish a receivable for any sales price
withheld by the factor• Debit Cash for net proceeds of the sale• Recognize a gain or loss from factoring
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60Example: FactoringAccounts Receivable
Assume:Factored Receivables $10,000Allowance for Bad Debts 300Factor Withholding 5
%Sales Price $ 8,500
Let’s journalize this Let’s journalize this transactiontransaction
Let’s journalize this Let’s journalize this transactiontransaction
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61Example: FactoringAccounts Receivable
Cash 8,075Receivable from Factor 425Allowance for Bad Debts 300Loss from Factoring Receivables 1,200
Accounts Receivable 10,000Computations
Cash: $8,500 – 425 = $8,075Factor Receivable: $8,500 x 5% = $425Factoring Loss: ($10,000 – 300) – $8,500 = $1,200
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62Sale of Receivableswith Recourse
Sale of receivables with recourse is different from factoring, since factoring
is normally sold on a nonrecourse basis.
Sale of receivables with recourse is different from factoring, since factoring
is normally sold on a nonrecourse basis.
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63Sale of Receivableswith Recourse
When receivables are sold with recourse, a purchaser of receivables retains the right to collect from the seller when the seller’s customers fail to make payments when due.
When receivables are sold with recourse, a purchaser of receivables retains the right to collect from the seller when the seller’s customers fail to make payments when due.
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64Sale of Receivableswith Recourse
A firm raises funds by selling $5,000 of A firm raises funds by selling $5,000 of its receivables for $4,300. The its receivables for $4,300. The
receivables have a net realizable value of receivables have a net realizable value of $4,700. The receivables are sold $4,700. The receivables are sold with with recourserecourse and the seller estimates (as and the seller estimates (as required by required by SFAS No. 140) SFAS No. 140) that the that the
recourse obligation has a fair value of recourse obligation has a fair value of $250. Assume in this illustration that the $250. Assume in this illustration that the factor does not withhold a percentage of factor does not withhold a percentage of
the purchase price.the purchase price.
A firm raises funds by selling $5,000 of A firm raises funds by selling $5,000 of its receivables for $4,300. The its receivables for $4,300. The
receivables have a net realizable value of receivables have a net realizable value of $4,700. The receivables are sold $4,700. The receivables are sold with with recourserecourse and the seller estimates (as and the seller estimates (as required by required by SFAS No. 140) SFAS No. 140) that the that the
recourse obligation has a fair value of recourse obligation has a fair value of $250. Assume in this illustration that the $250. Assume in this illustration that the factor does not withhold a percentage of factor does not withhold a percentage of
the purchase price.the purchase price.
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65Sale of Receivableswith Recourse
Cash received $4,300 Estimated value of recourse obligation (250)Net proceeds $4,050
Book value of the receivables $4,700 Net proceeds to be received (4,050)Loss on sale of receivables $ 650
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66Sale of Receivableswith Recourse
The entry to record the sale:
Cash 4,300Allowance for Bad Debts 300Loss on Sale of Receivables 650
Accounts Receivable 5,000Recourse Obligation 250
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Secured Borrowing
• Assignment of Accounts Receivable – There are no special accounting problems
involved.– Simply record the loan.
• Specific Assignment:– Specified accounts receivable pledged.– Accounts receivable reclassified on balance
sheet.– Footnote disclosure of loan provisions required.
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Notes Receivable
A promissory note is an unconditional written
promise to pay a certain sum of money at a
specified time.
A promissory note is an unconditional written
promise to pay a certain sum of money at a
specified time.
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Notes Receivable
• Initially recorded at present value.
• Two types:– Interest-bearing: Interest rate is stated on
the note.
– Noninterest-bearing: Interest is implied in the face amount of the note.
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Example: Notes Receivable
Assume:Note Receivable $1,000Interest Rate 10%Time to Maturity 2 years
Journalize this note as:1. An interest-bearing note.2. A noninterest-bearing note.
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Example: Notes Receivable
Interest-Bearing Note:Notes Receivable 1,000
Sales 1,000
Noninterest-Bearing Note:Notes Receivable 1,210
Sales 1,000
Discount on Notes Receivable 210
(PV of $1,000 @ 10% for
2 years = $1,210)
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• Discount Rate: The interest rate charged by the financial institution for buying a note receivable.
• Discount Period: The time between the date a note is sold to a financial institution and its maturity date.
Discounting Notes Receivables
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Formulas for Discounting Notes
Interest = Face amount x Interest
rate x Interest period
Maturity value = Face amount + Interest
Discount = Maturity value x Discount
period x Discount rate
Proceeds = Maturity value - Discount
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The EndThe End
chapter chapter 77
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