Prepared by: Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

C H A P T E R 7 Financial Assets: Cash and Receivables

Learning Objectives 1.Identify items considered cash. 2.Indicate how cash and related items are reported. 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.

Learning Objectives 6.Explain accounting issues related to recognition of notes receivable. 7.Explain accounting issues related to valuation of notes receivable. 8.Explain accounting issues related to disposition of accounts and notes receivable. 9.Explain how receivables are reported and analysed.

Cash and Receivables Cash What is cash? Management and control of cash Reporting cash Summary of cash- related items Receivables Recognition of accounts receivable Valuation of accounts receivable Recognition of notes receivable Valuation of notes receivable Disposition of accounts and notes receivable Presentation and analysis

Section 1: Cash

Cash and Cash Equivalents: Issues Cash –various items comprise cash Management and control of cash –the importance of internal control of cash Reporting of cash in the balance sheet

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 Postdated cheques, travel advances and stamps on hand are not classified as cash

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

Reporting of Cash The reporting of cash depends upon whether it is: 1.restricted cash 2.cash in foreign currencies 3.bank overdraft 4.cash equivalent

Restricted Cash Compensating balances: Cash balance amounts maintained by a corporation in support of existing borrowing arrangements Give the bank use of the restricted balance (funds are not available for use by the corporation) Classified as current assets separate from cash, if they relate to short-term loans Classified as non-current assets separate from cash, if they relate to long-term loans Note disclosure includes the nature of the financial arrangement and cash restriction

Foreign Currencies Amount held is reported in Canadian dollars Exchange rate used is the rate in effect on balance sheet date If restrictions exist on the foreign funds, those funds are reported as restricted

Bank Overdrafts Overdrafts represent cheques written in excess of cash account balance Overdrafts are reported as current liabilities Overdrafts may be offset against available cash in another account in the same bank Otherwise, such offsetting is not allowed

Cash Equivalents Short-term, highly liquid investments Can be converted to a known amount of cash Maturity date is generally three months or less Examples: –Treasury bills –Commercial paper –Money market funds

Section 2: Receivables

Accounts Receivable – Issues Types of accounts receivable –Current and non-current –Trade receivables Accounts receivable Notes receivable –Non-trade receivables Recognition and valuation of accounts receivable –Trade discounts –Cash discounts –Uncollectible accounts –Sales returns and allowances Recognition and valuation of notes receivable Disposition of receivables

Accounts Receivable: Recognition Trade (quantity) discounts are not recorded Cash (sales) discounts are inducements to customers for prompt payment of amounts billed Cash discounts are normally recorded and appear in books as a reduction of sales revenue

Accounts Receivable: Recording Cash Discounts There are two methods: –Gross –Net Gross method records discounts when taken by customers Net method records discounts not taken by customers

Accounts Receivable: Recording Cash Discounts 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 Gross MethodNet Method

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

Estimating Uncollectible Receivables Methods Direct Write-Off Allowance Not based on the matchingBased on the matchingprinciple 1 Accounts are written-offEstimated bad debts are when determined uncollectiblematched against revenue 2 Appropriate only ifMust be followed if amounts are not materialamounts are material 3

Estimating Uncollectible Accounts: The Allowance Method The estimate of uncollectible accounts may be based on: 1.percentage of sales (or net sales) 2.outstanding accounts receivable These approaches are referred to as Income Statement and Balance Sheet approaches (respectively) Both methods use an Allowance for Doubtful Accounts (contra account)

The Income Statement Approach Uses the relationship between sales and bad debts Matches the sales generated to the cost of bad debts estimated Any existing balance in the Balance Sheet account (Allowance for Bad Debts) is ignored when calculating the current year expense

The Income Statement Approach Example: Dockrill Corp. reports the following balances for the year 2000 (first year): – Credit sales:$400,000 The company estimates bad debts at 2% of net sales Determine estimated uncollectible accounts expense for 2000

The Income Statement Approach Est. uncollectible accounts (bad debts) expense: $400,000 * 2% = $8, To record bad debts expense: Bad Debts expense $8,000 Allowance for Doubtful Accounts $8,000 3 Regardless of the existing balance in the Allowance for Doubtful Accounts general ledger account, the Bad Debts Expense for the year is $8,000

Uses past collection experience to estimate bad debt expense Focus is on providing an estimate of accounts receivable value –Does not focus on matching sales to bad debt expense Any existing balance in Allowance for Doubtful Accounts is used to calculate the current year’s bad debt expense Two methods of calculation –Composite (single) rate –Aged receivable analysis The Balance Sheet Approach

The Balance Sheet Approach – Composite Rate Example: Wilson & Co. reports the following year-end balances for the year 2000: –Accounts Receivable:$547,000 –Allowance for Doubtful Accounts$ 800 The company estimates bad debts at 10% of accounts receivable Determine estimated uncollectible accounts expense for 2000

The Balance Sheet Approach – Composite Rate Calculate the required Allowance Account balance: $547,000 * 10% = $54,700 $ 54,700 - $800 = $53, To record bad debts expense: Estimated bad debts expense 53,900 Allowance for Uncollectible accounts53, : 53,900 Dec Adjusting entry 53,900 Year end balance 54,700 Bad debts expenseAllowance

The Balance Sheet Approach – Aged Receivable Analysis Wilson & Co. – Aging Schedule CustomerBalance< 60 Days 61 – 90 Days 91 – 120 Days > 120 Days Western$ 98,000$ 80,000$ 18,000 Brockway320,000 Freeport55,000 Allegheny74,00060,00014,000 $547,000$460,000$ 18,000$ 14,000$ 55,000 Estimated Uncollectibl e 4%15%20%25%

Calculate uncollectible accounts (bad debts) expense: 460,000 *.04$18,400 18,000 *.15 2,700 14,000 *.20 2,800 55,000 *.25 13,750 Required balance in the Allowance for Doubtful Accounts$37,650 Less: Current Balance 800 Bad Debts Expense $36, To record bad debts expense: Estimated bad debts expense 36,850 Allowance for Uncollectible accounts 36,850 The Balance Sheet Approach – Aged Receivable Analysis

The Allowance Method (Acct. Rec. Approach - Second Year) 36,850 Bad debts expense ,850 37,650 Allowance Adjusting entry: Bad Debts expense 36,850 Allowance account 36,850 Required ending allowance

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

Writing Off Accounts Receivable Allowance Method Dr. Allowance for Doubtful Accounts Cr. Accounts Receivable (for the amount to be written off) Bad Debts Expense is not used If the account is collected, after being written off, then: Dr. Accounts Receivable Cr. Allowance for Doubtful Accounts (for the amount collected) Dr. Cash Cr. Accounts Receivable (for the amount collected)

Writing Off Accounts Receivable Direct Method Dr. Bad Debts Expense Cr. Accounts Receivable (for the amount to be written off) If the account is collected, after being written off, then: Dr. Accounts Receivable Cr. Uncollectible Amounts Recovered (for the amount collected, with note on A/R sub ledger) Revenue Account

Section 3: Notes Receivable

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

Recognition of Notes Receivable Notes Receivable Short term N/RLong term N/R Record at face value less Allowance Record at present value of cash expected to be collected Issues at parIssues not at par

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

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

Discount on Notes Receivable Morgan Corp. issues a three-year note receivable to Marie Co. in the amount of $10,000 Stated Rate, 10%; Effective Rate, 12% Face Value of the note$10,000 PV of the principal (face value) n = 3, i = 12%$7,118 PV of the interest annuity ($10,000 * 10% = $1,000)n = 3, i = 12% $2,402 PV of the Note$ 9,520 Difference (= Discount)$ 480

Date Note is Signed: Notes Receivable 10,000 Discount on Notes Receivable 480 Cash 9,520 Discount on Notes Receivable Date Note is Collected: Discount (N/R) 142 Cash 1,000 Interest Revenue 1,142

Discount of Notes Receivable Discount is amortized using the effective interest method Amortized over the life of the note Straight-line method available only if the difference between effective interest and straight line method are immaterial

Section 4: Disposition of Accounts and Notes Receivable

The holder of accounts or notes receivable may transfer them for cash The transfer may be: – secured borrowing – 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) Disposition of Accounts and Notes Receivable

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

Accounting for Transfers of Receivables Secured Borrowing Sale Transfers Without RecourseWith Recourse Continuing involvement by seller No continuing involvement by seller

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

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)

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