Chapter 7

Cash and Receivables

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Preview of Chapter 7

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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

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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

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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

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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

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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

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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

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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).

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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?

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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?

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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)

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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.

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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

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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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