Chapter 7 CASH AND RECEIVABLES Continued Sommers – ACCT 3311 Acct 3311 - Class 24 Chapter 7 CASH AND RECEIVABLES Continued Sommers – ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.

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).

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).

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

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

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

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 1 2 3 4 n = 3 FV=10,000, pmt=1,000, n=3, i=12% => PV=9,520

Interest-bearing Note Illustration: How does Morgan record the receipt of the note?

Interest-bearing Note Illustration 7-15

Interest-bearing Note Journal Entries for Interest-Bearing Note Cash 1,000 Discount on notes receivable 142 Interest revenue 1,142

Discussion Question Q7-15 What is “imputed interest”? In what situations is it necessary to impute an interest rate for notes receivable?

Discussion Question Q7-15 Continued – What are the considerations in imputing an appropriate rate?

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).

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. Cash Interest Amort Balance 4/30/2011 29,890 4/30/2012 4/30/2013 4/30/2014 4/30/2015 4/30/2016

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. Cash Interest Amort Balance 4/30/2011 29,890 4/30/2012 - 1,793 31,683 4/30/2013 1,901 33,584 4/30/2014 2,015 35,599 4/30/2015 2,136 37,735 4/30/2016 2,265 40,000

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. Cash Interest Amort Balance 4/30/2011 29,890 4/30/2012 - 1,793 31,683 4/30/2013 1,901 33,584 4/30/2014 2,015 35,599 4/30/2015 2,136 37,735 4/30/2016 2,265 40,000

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? Cash Interest Amort Balance 4/30/2011 29,890 4/30/2012 - 1,793 31,683 4/30/2013 1,901 33,584 4/30/2014 2,015 35,599 4/30/2015 2,136 37,735 4/30/2016 2,265 40,000

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 Cash Interest Amort Balance 4/30/2011 29,890 4/30/2012 - 1,793 31,683 4/30/2015 2,136 37,735 4/30/2016 2,265 40,000

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.

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:

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?

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.

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

Disposition of Receivables Secured borrowing Now Cash XXX Payable XXX Get cash sooner, have A/R and payable on books Later A/R XXX Sale of Receivables Now Cash XXX A/R XXX Get cash sooner, but have nothing else on books Later Nothing

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.

Sale of Receivables Factors are finance companies or banks that buy receivables from businesses for a fee. Illustration 7-17

Sale of Receivables Sale Without Recourse Sale With 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

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.

Discussion Question Q7-21 What is the accounts receivable turnover ratio, and what type of information does it provide?

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.

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.

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.

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.

Receivables Journal Entries Weldon Corporation’s fiscal year ends December 31. The following is a list of transactions involving receivables that occurred during 2011: 3/17 Accounts receivable of $1,700 were written off as uncollectible. The company uses the allowance method. 3/30 Loaned an officer of the company $20,000 and received a note requiring principal and interest at 7% to be paid on March 30, 2012. 6/30 Sold merchandise to the Blankenship Company for $12,000. Terms of the sale are 2/10, n/30. Weldon uses the gross method to account for cash discounts. 7/8 The Blankenship Company paid its account in full. 8/31 Sold stock in a nonpublic company with a book value of $5,000 and accepted a $6,000 non-interest-bearing note with a discount rate of 8%. The $6,000 payment is due on February 28, 2012. The stock has no ready market value. 12/31 Bad debt expense is estimated to be 2% of credit sales for the year. Credit sales for 2011 were $700,000. Prepare all journal entries.

Receivables Journal Entries 3/17 Accounts receivable of $1,700 were written off as uncollectible. The company uses the allowance method. 3/30 Loaned an officer of the company $20,000 and received a note requiring principal and interest at 7% to be paid on March 30, 2012.

Receivables Journal Entries 6/30 Sold merchandise to the Blankenship Company for $12,000. Terms of the sale are 2/10, n/30. Weldon uses the gross method to account for cash discounts. 7/8 The Blankenship Company paid its account in full.

Receivables Journal Entries 8/31 Sold stock in a nonpublic company with a book value of $5,000 and accepted a $6,000 non-interest-bearing note with a discount rate of 8%. The $6,000 payment is due on February 28, 2012. The stock has no ready market value. 12/31 Bad debt expense is estimated to be 2% of credit sales for the year. Credit sales for 2011 were $700,000.

Receivables Journal Entries Adjusting Entries: