Chapter 7: Cash and Receivables Intermediate Accounting, 10th Edition Kieso, Weygandt, and Warfield Chapter 7: Cash and Receivables Prepared by Krishnan Ranganathan, Angelo State University, San Angelo, Texas

Part 1: Cash and Cash Equivalents 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

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 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

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 Post dated checks, travel advances and stamps on hand are not classified as cash 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Management and control of cash Since cash is the most liquid asset, internal control of cash is imperative. Controls must prevent unauthorized use of cash Management must have necessary information for proper use of cash 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) Reporting of Cash The reporting of cash depends upon whether it is: restricted cash a bank overdraft or a cash equivalent 1 2 3 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) Restricted Cash Compensating balances: are amounts maintained by a corporation with a bank in support of existing borrowing arrangements give bank use of the restricted balance are identified as current assets separate from cash, if they relate to short-term loans. are identified as non-current assets separate from cash, if they relate to long-term loans. 1 2 3 4 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) Bank Overdrafts Overdrafts represent checks written in excess of cash account. Overdrafts may be offset against available cash in another account in the same bank. Otherwise, such offsetting is not allowed. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Part 2: Accounts Receivable 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Accounts Receivable - Issues Types of accounts receivable : current and non-current : trade and non-trade Recognition of accounts receivable in the financial statements - cash discounts / interest Valuation of accounts receivable : estimated bad debts and net realizable value Disposition of receivable - transfers / sale 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Accounts Receivable: Recognition Trade or quantity discounts are not recorded in books of account. Cash (sales) discounts are inducements to customers for prompt payment of amounts billed. Cash discounts are recorded in books as reductions of sales revenue. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Accounts Receivable: Recording Cash Discounts There are two methods: Gross and Net Gross method records discounts when taken by customers. Net method records discounts not taken by customers. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Accounts Receivable: Recording Cash Discounts GROSS method NET method Record revenue at gross amount of sales When customer takes the discount, record cash discounts Cash discounts reduce gross sales revenue Record revenue at gross amount of sales less cash discount When customer forfeits discount, record discounts not taken. Report discounts forfeited as other revenue 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

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. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Estimating uncollectible receivables Methods Direct Write-Off Allowance Not based on the matching Based on the matching principle principle 1 Accounts are written off Estimated bad debts are when determined uncollectible matched against revenue 2 Appropriate only if Must be followed if amounts are not material amounts are material 3 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Estimating uncollectible accounts: the Allowance method The estimate of uncollectible accounts 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 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Sales method - 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. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Sales method - first year) Est. uncollectible accounts (bad debts) expense: $50,000 * 2% = $1,000 1 2 To record bad debts expense: Estimated bad debts expense Dr. $1,000 Allowance for Uncollectible accounts $1,000 2000: $1,000 closed Bad debts expense $1,000 Allowance 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Sales 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. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Sales approach - second year) Est. uncollectible accounts (bad debts) expense: $70,000 * 2% = $1,400 1 2 To record bad debts expense: Estimated bad debts expense Dr. $1,400 Allowance for Uncollectible accounts $1,400 2001: $1,400 closed Bad debts expense 2000:$1,000 2001:$1,400 Allowance 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Acct Rec 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 10% of accounts receivable. Determine estimated uncollectible accounts expense for 2000. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Acct Rec approach - first year) Est. uncollectible accounts (bad debts) expense: $4,600 * 10% = $460 1 2 To record bad debts expense: Estimated bad debts expense Dr. $460 Allowance for Uncollectible accounts $460 2000: $ 460 closed $ 460 Bad debts expense Allowance 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Acct Rec 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. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Acct Rec approach - second year) Est. uncollectible accounts (bad debts) expense: $5,700 * 10% = $ 570 (required) less: existing allowance = ($ 460) Bad debts expense (2001) = $110 1 2 To record bad debts expense: Estimated bad debts expense Dr. $110 Allowance for Uncollectible accounts $110 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

The Allowance method (Acct Rec approach - second year) 2001: $ 110 closed Bad debts expense $ 460 $ 110 $ 570 Allowance Required ending allowance Adjusting entry: Bad Debts expense Dr $110 Allowance account $ 110 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

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 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) Part 3: Notes Receivable 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Notes Receivable: Issues Recognition of Notes Receivable issues at face value and issues not at face value issues for cash / non-cash considerations Valuation issues Disposition of notes receivable 1 2 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Recognition of Notes Receivable Short term N/R Long term N/R Record at face value less Allowance Record at present value of cash expected to be collected Issues at par Issues not at par 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Recognition of Notes Receivable Notes receivable are issued at face value when the stated rate of interest is the same as the effective (market) rate. When the rates are unequal, a discount on the note results. The discount is amortized to interest revenue by the effective interest method. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Recognition of Notes Receivable Issues NOT at face value Non interest bearing Interest bearing 1. Determine discount on notes receivable at implicit rate of interest 2. The discount is amortized to interest revenue by the effective interest method 1. Determine discount on notes receivable at the effective rate of interest. 2. The discount is amortized to interest revenue by the effective interest method 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Discount on notes receivable: Example Assume Debrief company issues a notes receivable (FV= $10,000) on 1.1.2000. Stated Rate, 10%; Effective Rate, 12% The discount is $480. Assume that the discount to be amortized for 2000 is $ 142. Show necessary journal entries. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Discount on notes receivable Example 1.1.2000: Notes Receivable Dr. 10,000 Discount (N/R) $ 480 Cash $ 9,520 December 31, 2000: Discount (N/R) Dr. $ 142 Cash Dr. $ 1,000 Interest Revenue $1,142 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Disposition of Accounts and Notes Receivable Part 4: Disposition of Accounts and Notes Receivable 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Disposition of Accounts and Notes 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) 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Transfer of Receivables: borrowing vs. sale treatment Conditions 1. Are transferred assets isolated from transferor? and 2. Does transferee have right to pledge or sell assets? and 3. Has transferor divested itself of control through repurchase agreement? Yes Sale No Borrowing 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Accounting for Transfers of Receivables Secured Borrowing Sale Without Recourse With Recourse Continuing involvement by seller No continuing involvement by 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Secured Borrowing (highlights) Transferor records a finance charge. Transferor collects accounts receivable. Transferor records sales returns and sales discounts. Transferor absorbs bad debts expense. Transferor records interest expense on notes payable. Transferor pays on the note periodically from collections. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) Sale of Receivables Transferor transfers ownership of receivables to factor. Factor records the (transferred) accounts as assets in its books. Transferor records any amount retained by transferee as “due from factor” Transferor records loss on sale of receivables Transferor records any component liability (when appropriate) 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)

Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.) COPYRIGHT Copyright © 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 11/22/2018 Intermediate Accounting, 10th Edition, Ch. 7 (Kieso et al.)