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Chapter 7: Cash and Receivables

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  1. Chapter 7: Cash and Receivables Intermediate Accounting Kieso, Weygandt, and Warfield

  2. Part 1:Cash and Cash Equivalents Intermediate Accounting, Ch. 7 (Kieso et al.)

  3. Cash and Cash Equivalents: Issues • Definition of “cash” : various items that comprise cash. • Management and control of cash : the importance of internal control of cash • Reporting of cash in the balance sheet Intermediate Accounting, Ch. 7 (Kieso et al.)

  4. Items comprising “Cash” • Cash must be readily available and be free of restrictions • Cash consists of coins, currency and available funds • Deposits (CDs) and short term paper are classified as temporary investments, not cash • Post dated checks, travel advances and stamps on hand are not classified as cash Intermediate Accounting, Ch. 7 (Kieso et al.)

  5. Management and control of cash • Internal control of cash is imperative. • Controls must prevent unauthorized use of cash Intermediate Accounting, Ch. 7 (Kieso et al.)

  6. Reporting of Cash • Unique characteristics of cash : Restricted Cash, e.g. Compensating Balances are reported separate from Cash. Cash Equivalents: Short-term investments easily converted to a known amount of cash are included in Cash. • Examples: T-Bills, Commercial Paper and Money Market funds with original maturities of 90 days or less. 1 2 Intermediate Accounting, Ch. 7 (Kieso et al.)

  7. Restricted Cash • Compensating balances: • amounts maintained by a corporation with a bank in support of existing borrowing arrangements • gives bank use of the restricted balance • identified as current assetsseparate from cash, if they relate to short-term loans. • identified as non-current assetsseparate from cash, if they relate to long-term loans. 1 2 3 4 Intermediate Accounting, Ch. 7 (Kieso et al.)

  8. Part 2:Accounts Receivable Intermediate Accounting, Ch. 7 (Kieso et al.)

  9. Accounts Receivable: Recognition • Cash (sales) discounts are inducements to customers for prompt payment of amounts billed. • e.g. 2/10, n/30 • Cash discounts are recorded in books as reductions of sales revenue. Intermediate Accounting, Ch. 7 (Kieso et al.)

  10. Record revenue at gross amount of sales When customer takes the discount, record (debit) Sales Discounts Sales Discounts reduce gross sales revenue (contra) Record revenue at net amount (gross amount of sales less cash discount) When customer forfeits discount, debit A/R & credit Sales Discounts Forfeited. Report Sales Discounts Forfeited as other revenue Accounts Receivable: Recording Cash Discounts GROSS method NET method Intermediate Accounting, Ch. 7 (Kieso et al.)

  11. Valuation of Accounts Receivable • Short term receivables are reported at their net realizable value (NRV) • The NRV is the net amount expected to be collected • The NRV is gross accounts receivable less estimated uncollectible accounts. Intermediate Accounting, Ch. 7 (Kieso et al.)

  12. Estimating uncollectible A/R:the Allowance method • The estimate of uncollectible A/R may be based on: • either sales (or net sales) or • accounts receivable balance end of year • These approaches are referred to as Income Statement and Balance Sheet approaches Intermediate Accounting, Ch. 7 (Kieso et al.)

  13. The Allowance method (Income Statement approach - first year) • Indcom Company reports the following balances for the year 2000 (first year): • Net sales: $50,000 • Accounts Rec (Dec 31,2000): $4,600 • The company estimates bad debts at 2% of net sales. • Determine estimated uncollectible accounts expense for 2000. Intermediate Accounting, Ch. 7 (Kieso et al.)

  14. 1 Est. uncollectible accounts (bad debts) expense: $50,000 * 2% = $1,000 2 To record bad debts expense: Estimated bad debts expense Dr. $1,000 Allowance for Uncollectible accounts $1,000 Bad debts expense Allowance 2000: $1,000 closed $1,000 The Allowance method (Income Statementapproach - first year) Intermediate Accounting, Ch. 7 (Kieso et al.)

  15. The Allowance method (Income Statement approach - second year) • Indcom Company reports the following balances for the year 2001 (second year): • Net sales: $70,000 • Accounts Rec (Dec 31,2001): $5,700 • The company estimates bad debts at 2% of net sales. • Determine estimated uncollectible accounts expense for 2001. Intermediate Accounting, Ch. 7 (Kieso et al.)

  16. 1 Est. uncollectible accounts (bad debts) expense: $70,000 * 2% = $1,400 2 To record bad debts expense: Estimated bad debts expense Dr. $1,400 Allowance for Uncollectible accounts $1,400 Bad debts expense Allowance 2001: $1,400 closed 2000:$1,000 2001:$1,400 The Allowance method (Income Statement approach - second year) Intermediate Accounting, Ch. 7 (Kieso et al.)

  17. The Allowance method (Balance Sheetapproach - first year) • Indcom Company reports the following balances for the year 2000 (first year): • Net sales: $50,000 • Accounts Rec (Dec 31,2000): $4,600 • The company estimates bad debts at 10% of accounts receivable. • Determine estimated uncollectible accounts expense for 2000. Intermediate Accounting, Ch. 7 (Kieso et al.)

  18. 1 Est. uncollectible accounts (bad debts) expense: $4,600 * 10% = $460 2 To record bad debts expense: Estimated bad debts expense Dr. $460 Allowance for Uncollectible accounts $460 Bad debts expense Allowance 2000: $ 460 closed $ 460 The Allowance method (Balance Sheet approach - first year) Intermediate Accounting, Ch. 7 (Kieso et al.)

  19. The Allowance method (Balance Sheet approach - second year) • Indcom company reports the following balances for the year 2001 (second year): • Net sales: $70,000 • Accounts Rec (Dec 31,2001): $5,700 • The company estimates bad debts at 10% of accounts receivable. • Determine estimated uncollectible accounts expense for 2001. Intermediate Accounting, Ch. 7 (Kieso et al.)

  20. 1 Est. uncollectible accounts (bad debts) expense: $5,700 * 10% = $ 570 (required) less: existing allowance = ($ 460) Bad debts expense (2001) = $110 2 To record bad debts expense: Estimated bad debts expense Dr. $110 Allowance for Uncollectible accounts $110 The Allowance method (Balance Sheet approach - second year) Intermediate Accounting, Ch. 7 (Kieso et al.)

  21. Bad debts expense Allowance 2001: $ 110 closed $ 460 $ 110 $ 570 Required ending allowance The Allowance method (Balance Sheet approach - second year) Adjusting entry: Bad Debts expense Dr $110 Allowance account $ 110 Intermediate Accounting, Ch. 7 (Kieso et al.)

  22. Balance Sheet Representation • Short term accounts receivable are shown at their net realizable value as follows: • Accounts Receivable (gross) : $ XXX less: Allowance : ($ XX) Net Realizable Value : $ XX Intermediate Accounting, Ch. 7 (Kieso et al.)

  23. Part 3: Notes Receivable Intermediate Accounting, Ch. 7 (Kieso et al.)

  24. Notes Receivable Short term N/R Long term N/R Record at face value, interest not material (maturity <90 days) Record at present value of cash expected to be collected Issues at par Issues not at par Recognition of Notes Receivable Intermediate Accounting, Ch. 7 (Kieso et al.)

  25. Recognition of Notes Receivable • Notes receivable are issued at face value (par) when the stated rate of interest is the same as the effective (market) rate. • When the rates are unequal, a discount or premium on the note results. • The discount or premium is amortized using the effective interest method. Intermediate Accounting, Ch. 7 (Kieso et al.)

  26. Notes Receivable Example • Debrief Company accepts a three-year notes receivable (FV= $10,000) on 1/1/2001 in exchange for Consulting Services. • Stated Rate, 10%; Interest Only Paid Annually at End of Year; Effective Rate, 12% • Prepare the Journal Entries for Debrief Co. Intermediate Accounting, Ch. 7 (Kieso et al.)

  27. Discount on notes receivable: Example • PV of Note = PV of Face Amount + PV Interest Payments: • PV Principal = $10,000 (PV$ 3, 12%) = $10,000 (.71178) = $7,118 • PV Interest = $1,000 (PVA 3,12%)= = $1,000 (2.40183) = $2,402 • Total PV = $7118 + $2402= $9,520 • Discount = $10,000 - $9,520 = $480 Intermediate Accounting, Ch. 7 (Kieso et al.)

  28. Discount on Notes ReceivableJournal Entries • 1.1.2001: Notes Receivable $10,000 Discount (N/R) $ 480 Service Revenues $ 9,520 Intermediate Accounting, Ch. 7 (Kieso et al.)

  29. Note Discount Amortization(Market Rate = 12%) Intermediate Accounting, Ch. 7 (Kieso et al.)

  30. Discount on Notes ReceivableJournal Entries • 1.1.2001: Notes Receivable $10,000 Discount (N/R) $ 480 Service Revenues $ 9,520 • December 31, 2001: Discount (N/R)$ 142 Cash $ 1,000 Interest Revenue $1,142 Intermediate Accounting, Ch. 7 (Kieso et al.)

  31. Discount on Notes ReceivableJournal Entries • 12.31.2002: Discount (N/R)$ 159 Cash $ 1,000 Interest Revenue $1,159 • 12.31.2003: Discount (N/R)$ 179 Cash $ 1,000 Interest Revenue $1,179 Intermediate Accounting, Ch. 7 (Kieso et al.)

  32. Discount on Notes ReceivableJournal Entries • 12.31.2003: Cash $10,000 Notes Receivable $10,000 Intermediate Accounting, Ch. 7 (Kieso et al.)

  33. Part 4: Disposition of Accounts and Notes Receivable Intermediate Accounting, Ch. 7 (Kieso et al.)

  34. Disposition of Accounts andNotes Receivable • The holder of accounts or notes receivable may transfer them for cash. • The transfer may be: • secured borrowing or • a sale of receivables • Holder retains ownership of receivables in a secured borrowing transaction. • Holder transfers ownership of receivables in a sale (retaining risks of collection) Intermediate Accounting, Ch. 7 (Kieso et al.)

  35. Conditions 1. Are transferred assets isolated from transferor? and 2. Does transferee have right to pledge or sell assets? and 3. Has transferor surrendered right to repurchase or redeem assets before their maturity? Sale Yes Secured Borrowing No Transfer of Receivables:Borrowing vs. Sale Treatment Intermediate Accounting, Ch. 7 (Kieso et al.)