chapter 7 intermediate 15th ed

7-1

Prepared by Coby Harmon

University of California, Santa Barbara

Intermediate Accounting

Intermediate Accounting

Prepared by Coby Harmon

University of California, Santa BarbaraWestmont College

INTERMEDIATE

ACCOUNTINGF I F T E E N T H E D I T I O N

Prepared byCoby Harmon

University of California Santa BarbaraWestmont College

kiesoweygandtwarfieldteam for success

7-2

PREVIEW OF CHAPTER

Intermediate Accounting15th Edition

Kieso Weygandt Warfield

7

7-3

6. Explain accounting issues related to recognition and valuation of notes receivable.

7. Explain the fair value option.

8. Explain accounting issues related to disposition of accounts and notes receivable.

9. Describe how to report and analyze receivables.

After studying this chapter, you should be able to:

Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES

1. Identify items considered cash.

2. Indicate how to report cash and related items.

3. Define receivables and identify the different types of receivables.

4. Explain accounting issues related to recognition of accounts receivable.

5. Explain accounting issues related to valuation of accounts receivable.

7-4

Most liquid asset.

Standard medium of exchange.

Basis for measuring and accounting for all items.

Current asset.

Examples: coin, currency, available funds on deposit at

the bank, money orders, certified checks, cashier’s checks,

personal checks, bank drafts and savings accounts.

CashCash

LO 1 Identify items considered cash.

What is Cash?

7-5












7-6

Short-term, highly liquid investments that are both

CashCash

LO 2 Indicate how to report cash and related items.

Cash Equivalents

a) readily convertible to cash, and

b) so near their maturity that they present insignificant risk of changes in value.

Examples: Treasury bills, Commercial paper, and Money market funds.

Reporting Cash

7-7

Companies segregate restricted cash from “regular” cash.

Examples, restricted for:

(1) plant expansion, (2) retirement of long-term debt, and (3)

compensating balances.

Reporting CashReporting Cash

LO 2

Restricted Cash

Illustration 7-1

7-8

Company writes a check for more than the amount in its

cash account.

Reporting CashReporting Cash

LO 2 Indicate how to report cash and related items.

Bank Overdrafts

Generally reported as a current liability.

Offset against other cash accounts only when

accounts are with the same bank.

7-9

Cash-Related ItemsCash-Related Items

LO 2

Illustration 7-2

7-10












7-11

Accounts ReceivableAccounts Receivable

LO 3 Define receivables and identify the different types of receivables.

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 Accounts ReceivableReceivableAccounts Accounts

ReceivableReceivableNotes Notes

ReceivableReceivableNotes Notes

ReceivableReceivable

7-12

Nontrade Receivables

1. Advances to officers and employees.

2. Advances to subsidiaries.

3. Deposits paid to cover potential damages or losses.

4. Deposits paid 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.).



7-13



Illustration 7-3Receivables BalanceSheet Presentations

Nontrade Receivables

7-14












7-15

Recognition of Accounts ReceivablesRecognition of Accounts Receivables

LO 4 Explain accounting issues related to recognition of accounts receivable.

Reductions from the list

price.

Not recognized in the

accounting records.

Customers are billed net

of discounts.

10 %

Discount for

new Retail

Store

Customers

Trade Discounts

7-16



Offered to induce prompt

payment.

Gross Method vs. Net

Method.

Cash Discounts (Sales Discounts)

Payment terms are 2/10, n/30

7-17



Illustration 7-4Cash Discounts (Sales Discounts)

7-18

Illustration: On June 3, Bolton Company sold to Arquette Company

merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.

shipping point. On June 12, the company received a check for the

balance due from Arquette Company. Prepare the journal entries on

Bolton Company books to record the sale assuming Bolton records sales

using the gross method.

Sales

2,000

Accounts Receivable 2,000June 3



Cash ($2,000 x 98%) 1,960

Sales Discounts 40

Accounts Receivable 2,000

June 12

7-19



shipping point. On June 12, the company received a check for the

balance due from Arquette Company. Prepare the journal entries on

Bolton Company books to record the sale assuming Bolton records sales

using the net method.

Sales

1,960




Cash ($2,000 x 98%) 1,960


June 12

7-20



shipping point. Prepare the journal entries on Bolton Company books to

record the sale assuming Bolton records sales using the net method, and

Arquette did not remit payment until July 29.

Sales

1,960




Cash 2,000


Sales Discounts Forfeited 40

June 12

7-21

A company should measure receivables in terms of their

present value.

Non-Recognition of Interest Element


In practice, companies ignore

interest revenue related to accounts

receivable because the discount is

not

usually material in relation to the

net income for the period.


7-22

How are these accounts presented on the Balance Sheet?

Accounts ReceivableAllowance for

Doubtful Accounts

Beg. 500 25 Beg.

End. 500 25 End.

Accounts ReceivablesAccounts Receivables


7-23

Current Assets:

Cash 330$

Accounts receivable 500

Less: Allowance for doubtful accounts (25) 475

Inventory 812

Prepaid expense 40

Total current assets 1,657

Balance Sheet (partial)

ABC Corporation



7-24

Current Assets:

Cash 330$

Accounts receivable, net of $25 allowance 475

Inventory 812

Prepaid expense 40



ABC CorporationAlternate

PresentationAlternate

Presentation



7-25


Doubtful Accounts

Beg. 500 25 Beg.

End. 500 25 End.

Journal entry for credit sale of $100?

Accounts Receivable 100

Sales 100



7-26


Doubtful Accounts

Beg. 500 25 Beg.

End. 600 25 End.

Journal entry for credit sale of $100?


Sales 100

Sale 100



7-27


Doubtful Accounts

Beg. 500 25 Beg.

End. 600 25 End.

Sale 100

Collected $333 on account?

Cash 333




7-28


Doubtful Accounts

Beg. 500 25 Beg.

End. 267 25 End.

Sale 100

Collected $333 on account?

Cash 333


333 Coll.



7-29


Doubtful Accounts

Beg. 500 25 Beg.

End. 267 25 End.

Sale 100 333 Coll.

Adjustment of $15 for estimated bad debts?

Bad Debt Expense 15

Allowance for Doubtful Accounts 15



7-30


Doubtful Accounts

Beg. 500 25 Beg.

End. 267 40 End.

Sale 100 333 Coll.

Adjustment of $15 for estimated bad debts?

Bad Debt Expense 15

Allowance for Doubtful Accounts 15

15 Est.



7-31


Doubtful Accounts

Beg. 500 25 Beg.

End. 267 40 End.

Sale 100 333 Coll.

15 Est.

Write-off of uncollectible accounts for $10?

Allowance for Doubtful accounts 10




7-32


Doubtful Accounts

Beg. 500 25 Beg.

End. 257 30 End.

Sale 100 333 Coll.

15 Est.

Write-off of uncollectible accounts for $10?

Allowance for Doubtful accounts 10


W/O 10 10 W/O



7-33

Current Assets:

Cash 330$

Accounts receivable, net of $30 allowance 227

Merchandise inventory 812

Prepaid expense 40



ABC Corporation



7-34












7-35 LO 5 Explain accounting issues related to valuation of accounts receivable.


Reporting of receivables involves

1) classification and

2) valuation on the balance sheet.

Classification involves determining the length of time each

receivable will be outstanding.

Value and report short-term receivables at net realizable

value.

Valuation of Accounts Receivable


Valuation of Accounts ReceivableValuation of Accounts Receivable

Record credit losses as debits to Bad Debt Expense (or

Uncollectible Accounts Expense).

Normal and necessary risk of doing business on credit.

Two methods to account for uncollectible accounts:

1) the direct write-off method and

2) the allowance method.

Uncollectible Accounts Receivable


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.



Illustration 7-6


The percentage-of-sales basis results in a better matching of

expenses with revenues

The percentage-of-sales basis results in a better matching of

expenses with revenues

The percentage-of-receivablesbasis produces the better estimate of

net realizable value

The percentage-of-receivablesbasis produces the better estimate of

net realizable value


Percentage-of-Sales Approach

Percentage based upon past experience and anticipate

credit policy.

Achieves better matching of expenses with revenues.

Any balance in Allowance for Doubtful Accounts is

ignored.


7-40 LO 5

Illustration: Gonzalez Company estimates that about 1% of net

credit sales become uncollectible. If net credit sales for are

$800,000 for the year, it records bad debt expense as follows.

Bad Debt Expense 8,000

Allowance for Doubtful Accounts 8,000

Illustration 7-7



Percentage-of-Receivables Approach

Not matching.

Reports estimate of receivables at realizable value.

Companies may apply this method using

one composite rate, or

an aging schedule using different rates.





What entry would Wilson

make assuming that the

allowance account had a zero balance?

Illustration 7-8Accounts Receivable Aging Schedule



Bad Debt Expense ($37,650 – $800) 36,850


What entry would Wilson

make assuming the allowance account had a credit balance of $800 before

adjustment?

Illustration 7-8Accounts Receivable Aging Schedule


7-44


LO 5 Explain accounting issues related to valuation of accounts receivable.

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry to record bad debt

expense assuming Sandel Company estimates bad debts

at (a) 1% of net sales and (b) 5% of accounts receivable.

7-45


LO 5LO 5


Allowance for Doubtful Accounts 7,500($800,000 – $50,000) x 1% = $7,500

LO 5



Instructions: Prepare the journal entry assuming Sandel

estimates bad debts at (b) 1% of net sales.

7-46


LO 5LO 5

Instructions: Prepare the journal entry assuming Sandel

estimates bad debts at (b) 5% of accounts receivable.


Allowance for Doubtful Accounts 6,000($160,000 x 5%) – $2,000) = $6,000

LO 5



7-47

Illustration: The financial vice president of Brown Furniture

authorizes a write-off of the $1,000 balance owed by Randall Co. in

March 1. The entry to record the write-off is:


Accounts Receivable1,000

Assume that on July 1, Randall Co. pays the $1,000 amount that

Brown had written off on March 1. These are the entries:

Accounts Receivable 1,000Allowance for Doubtful Accounts

1,000

Cash 1,000Accounts Receivable

1,000

Write-Off of Uncollectible AccountsWrite-Off of Uncollectible Accounts

LO 5

7-48












7-49

Notes ReceivableNotes Receivable

LO 6 Explain accounting issues related to recognition and valuation of notes receivable.

Supported by a formal promissory note.

Written promise to pay a certain sum of money at a specific

future date.

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).

7-50


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 (majority of notes).


7-51

Recognition of Notes ReceivableRecognition of Notes Receivable

Short-Term Long-Term

Record at Face Value,

less allowance

Record at Present Value

of cash expected to be collected

Interest Rates

Stated rate = Market rate

Stated rate > Market rate

Stated rate < Market rate

Note Issued at

Face Value

Premium

Discount

LO 6

7-52

Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note?

Note Issued at Face ValueNote Issued at Face Value

0 1 2 3

1,000 1,000 Interest$1,000

$10,000 Principal

4

i = 10%

n = 3


7-53

$1,000 x 2.48685 = $2,487

Interest Received Factor Present Value


PV of Interest


7-54

$10,000 x .75132 = $7,513

Principal Factor Present Value


PV of Principal


7-55

Summary Present value of interest $ 2,487

Present value of principal 7,513

Note current market value $10,000


Notes Receivable 10,000Cash

10,000

Cash 1,000Interest Revenue

1,000


Jan. yr. 1

Dec. yr. 1

Journal Entries

7-56

Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note?

Zero-Interest-Bearing NoteZero-Interest-Bearing Note

0 1 2 3

$0 $0 Interest$0

$10,000 Principal

4

i = 9%

n = 3


7-57

$10,000 x .77218 = $7,721.80



PV of Principal


7-58


Illustration 7-12


7-59


Illustration 7-12


Notes Receivable 10,000.00

Discount on Notes Receivable2,278.20

Prepare the

journal entry to

record the receipt

of the note.

Cash 7,721.80

7-60


Illustration 7-12


Prepare the

journal entry to

record interest

revenue at the

end of the first

year.

Discount on Notes Receivable 694.96

Interest Revenue694.96

7-61

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. Prepare the journal entry to record the receipt of the note?

Interest-Bearing NoteInterest-Bearing Note

0 1 2 3

1,000 1,000 Interest$1,000

$10,000 Principal

4

i = 12%

n = 3


7-62

$1,000 x 2.40183 = $2,402

Interest Received Factor Present Value


PV of Interest


7-63

$10,000 x .71178 = $7,118



PV of Principal


7-64

Illustration: Record the receipt of the note?


Illustration 7-14

Notes Receivable 10,000

Discount on Notes Receivable

480

Cash

9,520LO 6 Explain accounting issues related to recognition

and valuation of notes receivable.

7-65


Illustration 7-15


7-66


Illustration 7-15


Cash 1,000

Discount on Notes Receivable 142

Interest Revenue 1,142

Prepare the journal

entry to record

interest revenue at

the end of the first

year.

7-67


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.


7-68


Illustration: 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:


Discount on Notes Receivable

15,247

Land

14,000

Gain on Disposal of Land

6,000

($35,247 - $20,000) = $15,247


7-69


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.

Valuation of Notes Receivable


7-70












7-71

Special IssuesSpecial Issues

Companies have the option to use fair value as the basis

of measurement in the financial statements.

If companies choose the fair value option

► Receivables are recorded at fair value.

► Unrealized holding gains or losses reported as part of

net income.

Company reports the receivable at fair value each

reporting date.

Fair Value Option

LO 7 Explain the fair value option.

7-72

Special IssuesSpecial Issues

Companies may elect at time the financial instrument is

► originally recognized or

► when some event triggers a new basis of accounting.

Must continue to use fair value measurement for the specific

instrument until the company no longer owns this

instrument.

If not elected at date of recognition, company may never

use fair value option on that specific instrument.

Fair Value Option


7-73

Valuation of Notes ReceivableValuation of Notes Receivable


Illustration: Escobar Company has notes receivable that have a

fair value of $810,000 and a carrying amount of $620,000. Escobar

decides on December 31, of the current year, to use the fair value

option for these receivables. This is the first valuation of these

recently acquired receivables. At December 31, Escobar makes an

adjusting entry to record the increase in value of Notes Receivable

and to record the unrealized holding gain, as follows.


Unrealized Holding Gain or Loss—Income 190,000

7-74












7-75

Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable

Owner may transfer accounts or notes receivables to

another company for cash. Reasons:

Competition.

Sell receivables because money is tight.

Billing and collection are time-consuming and costly.

Transfer accomplished by:

Secured borrowing.

Sale of receivables.

LO 8 Explain accounting issues related to disposition of accounts and notes receivable.

7-76

Secured Borrowing

Illustration: March 1, 2014, Howat Mills, Inc. provides

(assigns) $700,000 of its accounts receivable to Citizens Bank

as collateral for a $500,000 note. Howat Mills continues to

collect the accounts receivable; the account debtors are not

notified of the arrangement. Citizens Bank assesses a finance

charge of 1 percent of the accounts receivable and interest on

the note of 12 percent. Howat Mills makes monthly payments to

the bank for all cash it collects on the receivables.



7-77 LO 8

Secured BorrowingIllustration 7-16

7-78

Illustration: On April 1, 2014, Prince Company assigns $500,000 of its

accounts receivable to the Third National Bank as collateral for a $300,000

loan due July 1, 2014. The assignment agreement calls for Prince Company

to continue to collect the receivables. Third National Bank assesses a

finance charge of 2% of the accounts receivable, and interest on the loan is

10% (a realistic rate of interest for a note of this type).

Secured BorrowingSecured Borrowing

Instructions:

a) Prepare the April 1, 2014, journal entry for Prince Company.

b) Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2014, through June 30, 2014.

c) On July 1, 2014, Prince paid Third National all that was due from the loan it secured on April 1, 2014.


7-79

Instructions:

a) Prepare the April 1, 2014, journal entry for Prince Company.

b) Prepare the journal entry for Prince’s collection of $350,000.

c) On July 1, 2014, Prince paid Third National all that was.

Secured BorrowingSecured Borrowing

Cash 290,000

Finance Charge ($500,000 x 2%) 10,000

Notes Payable

300,000

a)

Cash 350,000

Accounts Receivable

350,000

b)

Notes Payable 300,000

Interest Expense (10% x $300,000 x 3/12) 7,500

Cash

307,500

c)

LO 8

7-80

Sale Without Recourse

Purchaser assumes risk of collection.

Transfer is outright sale of receivable.

Seller records loss on sale.

Sale With Recourse

Seller guarantees payment to purchaser.

Financial components approach used to record transfer.



Sales of Receivables

7-81

Factors are finance companies or banks that buy receivables

from businesses for a fee.

Sales of ReceivablesSales of Receivables

Illustration 7-17

LO 8

7-82


Illustration: Crest Textiles, Inc. factors $500,000 of accounts

receivable with Commercial Factors, Inc., on a without recourse

basis. Commercial Factors assesses a finance charge of 3 percent of

the amount of accounts receivable and retains an amount equal to 5

percent of the accounts receivable (for probable adjustments). Crest

Textiles and Commercial Factors make the following journal entries

for the receivables transferred without recourse.

Illustration 7-18


7-83

Illustration: Assume Crest Textiles sold the receivables on a with

recourse basis. Crest Textiles determines that this recourse

obligation has a fair value of $6,000. To determine the loss on the

sale of the receivables, Crest Textiles computes the net proceeds

from the sale as follows.


Illustration 7-20Loss on Sale Computation

Illustration 7-19Net ProceedsComputation

LO 8

7-84

Illustration: Prepare the journal entries for both Crest Textiles and

Commercial Factors for the receivables sold with recourse.


Cash 460,000

Due from Factor 25,000

Loss on Sale of Receivables 21,000

Accounts (Notes) Receivable

500,000

Recourse Liability

6,000Accounts Receivable 500,000

Due to Customer (Crest Textiles)

25,000

Interest Revenue

15,000

Cash

460,000

Commercial Factors, Inc.

Crest Textiles, Inc.

LO 8

7-85

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 versus SaleSecured Borrowing versus Sale

Illustration 7-22

LO 8

7-86












7-87

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 and AnalysisPresentation and Analysis

LO 9 Describe how to report and analyze receivables.

Presentation of Receivables

7-88

Analysis of Receivables

Presentation and AnalysisPresentation and Analysis

Accounts Receivable Turnover Ratio:

Use to evaluate the liquidity of accounts receivable.

Measures the number of times, on average, a company

collects receivables during the period.

Illustration 7-24

LO 9 Describe how to report and analyze receivables.

7-89 LO 10 Explain common techniques employed to control cash.

Management faces two problems in accounting for cash

transactions:

1. Establish proper controls to prevent any unauthorized

transactions by officers or employees.

2. Provide information necessary to properly manage cash on

hand and cash transactions.

APPENDIXAPPENDIX 7A CASH CONTROLS


To obtain desired control objectives, a company can vary the

number and location of banks and the types of accounts.

General checking account

Collection float.

Lockbox accounts

Imprest bank accounts

Using Bank Accounts



To pay small amounts for miscellaneous expenses.

The Imprest Petty Cash System

Steps:

1. Record $300 transfer of funds to petty cash:

Petty Cash 300

Cash 300

2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.


7-92

Steps:

LO 10 Explain common techniques employed to control cash.


Supplies Expense 42

Postage Expense 53

Miscellaneous Expense 76

Cash Over and Short 2

Cash 173

3. Custodian receives a company check to replenish the fund.


7-93

Steps:



Cash 50

Petty cash 50

4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows.



Physical Protection of Cash Balances

Company should

Minimize the cash on hand.

Only have on hand petty cash and current day’s receipts.

Keep funds in a vault, safe, or locked cash drawer.

Transmit each day’s receipts to the bank as soon as

practicable.

Periodically prove (reconcile) the balance shown in the general

ledger.



Reconciliation of Bank Balances

Schedule explaining any differences between the bank’s

and the company’s records of cash.

Reconciling Items:

1. Deposits in transit.

2. Outstanding checks.

3. Bank charges and credits.

4. Bank or Depositor errors.

Time Lags



Reconciliation of Bank Balances Illustration 7A-1Bank Reconciliation Form and Content


7-97 LO 10


7-98

Illustration 7A-2


Advance slide in presentation mode to reveal answer.

7-99

Cash 542Nov. 30

Office Expense 18


Accounts Payable

180Interest Revenue

600

Illustration: Journalize the adjusting entry on the books of

Nugget Mining Company.



7-100

The reconciling item in a bank reconciliation that will result

in an adjusting entry by the depositor is:

a. outstanding checks.

b. deposit in transit.

c. a bank error.

d. bank service charges.

Question



7-101

APPENDIXAPPENDIX 7B7B IMPAIRMENT OF RECEIVABLES

LO 11 Describe the accounting for a loan impairment.

Companies evaluate their receivables to determine their

ultimate collectibility.

Allowance method is appropriate when:

probable that an asset has been impaired and

amount of the loss can be reasonably estimated.

Long-term receivables such as loans that are identified as

impaired, companies perform an additional impairment

evaluation.

7-102 LO 11 Describe the accounting for a loan impairment.

Impairment Measurement and Reporting

Impairment loss is calculated as the difference between

the investment in the loan (generally the principal plus

accrued interest) and

the expected future cash flows discounted at the loan’s

historical effective-interest rate.

APPENDIXAPPENDIX 7B IMPAIRMENT OF RECEIVABLES


Illustration: At December 31, 2013, Ogden Bank recorded an

investment of $100,000 in a loan to Carl King. The loan has an

historical effective-interest rate of 10 percent, the principal is due in full

at maturity in three years, and interest is due annually. The loan officer

performs a review of the loan’s expected future cash flow and utilizes

the present value method for measuring the required impairment loss.

Illustration 7B-1



Illustration 7B-2

Recording Impairment Loss




Illustration: Computation of impairment loss.

7-105

Floyd Norris, noted financial writer for the New York Times, recently wrote in his blog that he attended a conference to discuss the financial crisis in subprime lending. He highlighted, and provided “translations” of, some of the statements he heard at that conference:

• “There is a problem of misaligned incentives.”

Translation: Many parties in the lending process were complicit in not performing due diligence on loans because there were lots of fees to be had if the loans were made, good loans or bad.

• “It is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models.”

Translation: The rating agencies that evaluated the risk level of these securities made many miscalculations. Some structured finance products that were given superior ratings are no longer worth much.

• “The plumbing of the U.S. economy has been deeply damaged. It is a long window of vulnerability.”

WHAT’S YOUR PRINCIPLELOST IN TRANSLATION

Translation: The U.S. has caused a financial crisis as a result of poor lending practices, and many financial institutions are fighting to survive.

• “I’m glad that this time we did not cause it.”

Translation: Other countries realized they had caused financial crises in the past but were not to blame for the current U.S. financial situation.

• “What you see is what you get. If you don’t see it, it will get you.”

Translation: A large number of financial institutions have to take losses on assets that are not reported on their balance sheet. Their continuing interest in some of the loans that they supposedly sold is now coming back to them and they will have to report losses.

Source: Floyd Norris blog, http://www.norris.blogs.nytimes.com/

(accessed June 2008).

LO 11

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LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.

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.

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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.

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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.

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ON THE HORIZON

Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. That said, in IFRS 9, which was issued in 2009, the IASB created a split model, where some financial instruments are recorded at fair value but other financial assets, such as loans and receivables, can be accounted for at amortized cost if certain criteria are met. Critics say that this can result in two companies with identical securities accounting for those securities in different ways. A proposal by the FASB would require that nearly all financial instruments, including loans and receivables, be accounted for at fair value. It has been suggested that IFRS 9 will likely be changed or replaced as the FASB and IASB continue to deliberate the best treatment for financial instruments. In fact, one member of the IASB said that companies should ignore IFRS 9 and continue to report under the old standard, because in his opinion, it is extremely likely that it would be changed before the mandatory adoption date of this standard in 2013.

LO 12

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Under IFRS, receivables are to be reported on the balance sheet at:

a. amortized cost.

b. amortized cost adjusted for estimated loss provisions.

c. historical cost.

d. replacement cost.

IFRS SELF-TEST QUESTION


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Which of the following statements is false?

a. Receivables include equity securities purchased by the

company.

b. Receivables include credit card receivables.

c. Receivables include amounts owed by employees as result of

company loans to employees.

d. Receivables include amounts resulting from transactions with

customers.



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Under IFRS:

a. the entry to record estimated uncollected accounts is the same

as GAAP.

b. loans and receivables should only be tested for impairment as a

group.

c. it is always acceptable to use the direct write-off method.

d. all financial instruments are recorded at fair value.



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chapter 7 intermediate 15th ed

Business

cash accounts

accounting issues

regular cash

valuation of notes receivable

different types of receivables

disposition of accounts

receivable receivablelo

savings accounts