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Chapter 6 – Time Value of Money

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  1. Chapter 6 – Time Value of Money Tell me what you did for partial credit PV FV Pmt n i Solve using Formulas – Have at it Tables – Bring your own copies Calculators – See syllabus for models and also refer to the “tutorials” linked to on the website
  2. Chapter 7CASH AND RECEIVABLESSommers – Intermediate I
  3. Reporting Cash Bank Overdrafts Company writes a check for more than the amount in its cash account. Generally reportedas a current liability. Offset against other cash accounts only when accounts are with the same bank.
  4. Accounts Receivable 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 Receivable Notes Receivable
  5. Accounts Receivable Nontrade Receivables Advances to officers and employees. Advances to subsidiaries. Deposits to cover potential damages or losses. Deposits as a guarantee of performance or payment. Dividends and interest receivable. 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.).
  6. Trade Discounts Reductions from the list price Not recognized in the accounting records Customers are billed net of discounts
  7. Cash (Sales) Discounts Inducements for prompt payment Gross Method vs. Net Method Payment terms are 2/10, n/30
  8. Big Customers Are Slow to Pay – WSJ Jun 7, 2012
  9. Sales and Trade Discounts Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30. Assume the gross method of accounting for cash discounts is used. Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.
  10. Sales and Trade Discounts Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30. Assume the gross method of accounting for cash discounts is used. Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.
  11. Sales and Trade Discounts Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30. Assume the net method of accounting for cash discounts is used. Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.
  12. Sales and Trade Discounts Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30. Assume the net method of accounting for cash discounts is used. Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.
  13. Non-Recognition of Interest A company should measure receivables in terms of their present value. In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period.
  14. Recognition of A/R How are these accounts presented on the Balance Sheet? Allowance for Doubtful Accounts Accounts Receivable Beg. 500 25 Beg. End. 500 25 End.
  15. Recognition of A/R
  16. Recognition of A/R
  17. Uncollectible A/R An uncollectible account receivable is a loss of revenue that requires, through proper entry in the accounts, a decrease in the asset accounts receivable and a related decrease in income and stockholders’ equity.
  18. Direct Write-Off vs. Allowance Method 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.
  19. Percentage of Sales vs. Receivables Emphasis on the Income Statement relationships Emphasis on the Balance Sheet relationships
  20. Percentage of Sales Approach Percentage-of-Sales Approach Percentage based upon past experience and anticipate credit policy. Achieves proper matching of costs with revenues. Existing balance in Allowance account not considered.
  21. Example 1a West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year: Accounts receivable $ 900,000 Allowance for bad debts (credit balance) 16,000 Credit sales for 2009 1,750,000 West uses the following method of estimating bad debts for 2009: Based on 2% of credit sales. What amount should West charge to bad debt expense at the end of 2009 under Percentage of Sales (income statement) method?
  22. Percentage-of-Receivables Approach Percentage-of-Receivables Approach Not matching. Reports receivables at realizable value. Companies may apply this method using one composite rate, or an aging schedule using different rates.
  23. Example 1b West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year: Accounts receivable $ 900,000 Allowance for bad debts (credit balance) 16,000 Credit sales for 2009 1,750,000 West uses the following method of estimating bad debts for 2009: Based on 5% of year-end accounts receivable. What amount should West charge to bad debt expense at the end of 2009 under Percentage of Accounts Receivable (balance sheet) method?
  24. A/R Aging Adjustment What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?
  25. Bad Debt Problem Swathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows: Beginning balance $ 574,000 Credit sales 2,620,000 Collections (2,483,000) Write-offs (68,000) Ending balance $ 643,000 The company’s controller prepared the following aging summary of year-end accounts receivable: Age GroupAmount% Uncollectible 0-60 days $430,000 4% 61-90 days 98,000 15% 91-120 days 60,000 25% Over 120 days 55,000 40% Totals $643,000 Prepare a summary journal entry to record the monthly bad debt accrual and the write-offs during the year.
  26. Bad Debt Problem During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. Accounts receivable activity for 2011 was as follows: Beginning balance $ 574,000 Credit sales 2,620,000 Collections (2,483,000) Write-offs (68,000) Ending balance $ 643,000
  27. Bad Debt Problem Swathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows: Beginning balance $ 574,000 Credit sales 2,620,000 Collections (2,483,000) Write-offs (68,000) Ending balance $ 643,000 The company’s controller prepared the following aging summary of year-end accounts receivable: Age GroupAmount% Uncollectible 0-60 days $430,000 4% 61-90 days 98,000 15% 91-120 days 60,000 25% Over 120 days 55,000 40% Totals $643,000 Prepare the necessary year-end adjusting entry for bad debt expense.
  28. Bad Debt Problem Swathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Age GroupAmount% UncollectibleAllowance 0-60 days $430,000 4% $17,200 61-90 days 98,000 15% 14,700 91-120 days 60,000 25% 15,000 Over 120 days 55,000 40% 22,000 $68,900 ABD
  29. Bad Debt Problem What is total bad debt expense for 2011? How would accounts receivable appear in the 2011 balance sheet?
  30. Example 2a SandelCompany reports the following financial information before adjustments. Prepare the journal entry to record bad debt expense assuming Sandel estimates bad debts at (a) 1% of net sales.
  31. Example 2b SandelCompany reports the following financial information before adjustments. Prepare the journal entry to record bad debt expense assuming Sandel estimates bad debts at (b) 5% of accounts receivable.
  32. Effect of Write-Offs On May 6, Timberland wrote off a specific account receivable with balance of $2,500. Assume that before the write-off entry, Timberland’s Accounts Receivable balance was $81,000,000 and the Allowance for Doubtful Accounts balance was $2,000,000. What effect did the write-off have?
  33. Reversal of Write-Off Assume that the financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. on March 1, 2012. The entry to record the write-off is: Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries: LO 5
  34. Notes Receivable Supported by a formal promissory note. 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).
  35. Notes Receivable.. 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 (the majority of notes).
  36. Note Receivable Journal Entries On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation. Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold). June 30, 2011
  37. Note Receivable Journal Entries On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation. Prepare the journal entry at December 31, 2011. December 31, 2011
  38. Note Receivable Journal Entries On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation. Prepare the journal entry at March 31, 2012. March 31, 2012
  39. Interest-bearing Note 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. How does Morgan record the receipt of the note? i = 12% $10,000 Principal $1,000 1,000 1,000 Interest 0 1 2 3 4 n = 3 FV=10,000, pmt=1,000, n=3, i=12% => PV=9,520
  40. Interest-bearing Note Illustration: How does Morgan record the receipt of the note?
  41. Interest-bearing Note Illustration 7-15
  42. Interest-bearing Note Journal Entries for Interest-Bearing Note
  43. Discussion Question Q7-15 What is “imputed interest”? In what situations is it necessary to impute an interest rate for notes receivable?
  44. Discussion Question Q7-15 Continued – What are the considerations in imputing an appropriate rate?
  45. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold).
  46. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. Prepare the amortization schedule.
  47. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. Prepare the journal entry at December 31, 2011. December 31, 2011
  48. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. Prepare the journal entry at December 31, 2012. December 31, 2012
  49. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. What is the balance of the note at December 31, 2012?
  50. Non-Interest Bearing Note On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation. Prepare the journal entry at April 30, 2016. April 30, 2016
  51. 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: No interest rate is stated, or Stated interest rate is unreasonable, or Face amount of the note is materially different from the current cash sales price.
  52. Notes Receivable Example 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:
  53. Discussion Question Q7-16 What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?
  54. Valuation of Notes Receivable 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. Fair Value Option. Companies have the option to use fair value as the basis of measurement in the financial statements. Adjustments to value go through net income.
  55. Disposition of Receivables Owner may transfer accounts or notes receivables to another company for cash. Reasons: Competition. Sell receivables because money is tight. Billing / collection are time-consuming and costly. Transfer accomplished by: Secured borrowing Sale of receivables
  56. Disposition of Receivables Secured borrowing Now Cash XXX Payable XXX Get cash sooner, have A/R and payable on books Later Cash XXX A/R XXX Payable XXX Cash XXX Sale of Receivables Now Cash XXX A/R XXX Get cash sooner, but have nothing else on books Later Nothing
  57. Secured borrowing vs. Sale The FASB concluded that a sale occurs only if the seller surrenders control of the receivables to the buyer. Three conditions must be met.
  58. Sale of Receivables Factorsare finance companies or banks that buy receivables from businesses for a fee. Illustration 7-17
  59. Sale of Receivables Sale Without Recourse Purchaser assumes risk of collection Transfer is outright sale of receivable Seller records loss on sale Seller uses Due from Factor (receivable) account to cover discounts, returns, and allowances Sale With Recourse Seller guarantees payment to purchaser Financial components approach used to record transfer
  60. Presentation of Receivables Segregate the different types of receivables that a company possesses, if material. Appropriately offset the valuation accounts against the proper receivable accounts. Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer. Disclose any loss contingencies that exist on the receivables. Disclose any receivables designated or pledged as collateral. Disclose the nature of credit risk inherent in the receivables.
  61. Discussion Question Q7-21 What is the accounts receivable turnover ratio, and what type of information does it provide?
  62. A/R Turnover Ratio This Ratio used to: Assess the liquidity of the receivables. Measure the number of times, on average, a company collects receivables during the period.
  63. 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.
  64. IFRS 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.
  65. IFRS 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.