1. Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and Technology Updated for IFRS by: Anupma Goel, CA Seneca College of Applied Arts and Technology Chapter 7 Cash and Receivables

2. 2 Cash and Receivables Cash What is cash?What is cash? Management and control of cashManagement and control of cash Reporting cashReporting cash Summary of cash-related itemsSummary of cash-related items Presentation, Perspectives, and International Standards Presentation of receivables and loansPresentation of receivables and loans PerspectivesPerspectives Canadian GAAP and international accounting standards-a comparisonCanadian GAAP and international accounting standards-a comparison Disposition of Receivables Secured borrowingsSecured borrowings Sales of receivablesSales of receivablesReceivables IntroductionIntroduction Recognition and measurement of accounts receivableRecognition and measurement of accounts receivable Valuation of accounts receivableValuation of accounts receivable Recognition, measurement, and valuation of short- term notes receivableRecognition, measurement, and valuation of short- term notes receivable Recognition and measurement of long-term loansRecognition and measurement of long-term loans Appendix- Cash Controls Using bank accountsUsing bank accounts The imprest petty cash systemThe imprest petty cash system Physical protection of cash balancesPhysical protection of cash balances Reconciliation of bank balancesReconciliation of bank balances

3. 3 Financial Asset “Any asset that is: (i) cash; (ii) a contractual right to receive cash or another financial asset from another party; (iii) a contractual right to exchange financial instruments with another party under conditions that are potentially favourable to the entity; or (iv) an equity instrument of another entity” CICA Handbook, Section 3855.19

4. 4 Cash Section 1:

5. 5 What is Cash? Cash is reported as a current asset if it is readily available to pay current obligations and is free of restrictions Cash consists of coins, currency, available funds on deposit at the bank, and petty cash Also includes money orders, certified cheques, cashier’s cheques, personal cheques, bank drafts, and usually savings accounts Postdated cheques, travel advances, and stamps on hand are not classified as cash

6. 6 Management and Control of Cash There are many risks associated with cash Since cash is the most liquid asset, effective internal control of cash is imperative Internal controls need to prevent unauthorized use of cash Management must have all necessary information to properly manage cash

7. 7 Reporting of Cash Reporting cash needs special attention of the following: 1.Restricted cash 2.Cash in foreign currencies 3.Bank overdrafts 4.Cash equivalents

8. 8 Restricted Cash Compensating balances: minimum cash balances maintained by a corporation in support of existing borrowings These funds are not available for use by the corporation, but the bank can use the restricted cash Petty cash, special payroll, and dividend accounts are examples of cash set aside for a special purpose (usually not material)

9. 9 Restricted Cash If the compensating balance is material, must be segregated from Cash as follows: -Classified as current assets if they relate to short-term loans -Classified as non-current assets if set aside for investment or financing purposes (e.g. plant expansion) Note disclosure of restricted cash is required

10. 10 Foreign Currencies Amount held in foreign currencies is reported in Canadian dollars at the balance sheet date The exchange rate on the balance sheet date is used to translate foreign currencies into Canadian dollars If restrictions exist on the foreign funds, those funds are reported as restricted

11. 11 Bank Overdrafts Overdrafts represent cheques written in excess of the cash account balance Overdrafts are reported as current liabilities (often reported as accounts payable) In general, bank overdrafts should not be offset against the Cash account However, bank overdrafts may be offset against available cash in another account if both accounts are at the same bank

12. 12 Cash Equivalents Defined as “short-term, highly liquid investments that are readily convertible to known amounts of cash…subject to an insignificant risk of change in value.” Original maturity is generally three months or less Excludes equity securities Examples: treasury bills, money-market funds, commercial paper Cash equivalents are reported at fair value Under IFRS some equity instruments can be classified as cash equivalents. For example, preferred shares acquired within a short time of their maturity and with a specified redemption date.

13. 13 Receivables Section 2:

14. 14 Receivables: Introduction Loans and receivables are claims against customers and other parties for money, goods, or services Receivables are classified as either current (short-term) or noncurrent (long-term) Classified as current receivables if there is the expectation to collect within one year or operating cycle (whichever is longer) Receivables can be classified as either trade receivables or nontrade receivables

15. 15 Accounts Receivable: Issues Trade receivables include: Accounts receivable (verbal promise to pay, normally within 30 to 60 days) Notes receivable (written promises with specified terms, e.g. interest rate and due date) Nontrade receivables include the following: 1.Advances to employees or other officers 2.Receivables from the government (e.g. GST recoverable, income tax receivable) 3.Dividends and interest receivable 4.Amounts owing by insurance companies

16. 16 Accounts Receivable: Trade Discounts vs. Cash Discounts Trade discounts are discounts given to customers often for different quantities purchased (often quoted as a percentage) Trade discounts are not recorded; the price charged (net of the discount) is recorded by the seller as a receivable and revenue Cash discounts (or sales discounts) encourage customers to pay faster; they are recorded Example of cash discounts: 2/10, n/30; the customer will receive a 2% discount if payment made within 10 days and the gross amount of the invoice is due in 30 days

17. 17 Accounts Receivable: Recording Cash Discounts Two methods: gross method and net method Gross method records discounts when customers pay within discount period –“Sales Discounts” are deducted from sales on the income statement –Most common method Net method records accounts receivable net of the discount; discounts forfeited by customers are recorded when not taken –Preferred method but rarely used –“Sales Discounts Forfeited” is recorded as “Other revenue” if customer does not take the discount

18. 18 Example of Gross Method $10,000 sales on credit (terms 2/10, n/30) DR Accounts Receivable 10,000 CR Sales Revenue 10,000 Customer pays account within discount period DR Cash9,800 DR Sales Discounts 200 CR Accounts Receivable 10,000

19. 19 Example of Net Method $10,000 sales on credit (terms 2/10, n/30) DR Accounts Receivable 9,800 CR Sales Revenue 9,800 Customer pays account after discount period DR Cash10,000 CR Sales Discounts Forfeited 200 CR Accounts Receivable 9,800

20. 20 Valuation of Accounts Receivable Short-term receivables are reported at their net realizable value (NRV) The NRV is the net amount of cash expected to be collected, which is not necessarily the amount legally receivable Calculated as: Gross accounts receivable less estimated uncollectible accounts and any returns, allowances, or cash discounts

21. 21 Estimating Uncollectible Receivables The Allowance Method Records estimated bad debt expense in the same accounting period as the sale (matching concept) Receivables are reported at their estimated realizable value – i.e., net of an Allowance for Doubtful Accounts

22. 22 Estimating Uncollectible Accounts: The Allowance Method The estimate of uncollectible accounts may be based on: Percentage of Sales (or net sales) – referred to as the Income Statement approach Outstanding Accounts Receivable – referred to as the Balance Sheet approach Many companies use the % of sales method during the year and adjust at year end based on the receivables approach

23. 23 The Income Statement Approach Uses the relationship between sales and bad debts Matches the estimated cost of bad debts to sales generated in the same accounting period Any existing balance in the balance sheet account (Allowance for Doubtful Accounts) is ignored when calculating the current year’s bad debts expense

24. 24 The Income Statement Approach Example: Dockrill Corp. reports the following balances for its first year of operations (2007): – Net credit sales:$400,000 The company estimates bad debts at 2% of net credit sales Determine estimated bad debts expense for 2007

25. 25 The Income Statement Approach Estimated Bad Debts Expense: $400,000 x 2% = $8,000 $400,000 x 2% = $8,0001 2 To record Bad Debts Expense: Bad Debts Expense $8,000 Allowance for Doubtful Accounts $8,000 Allowance for Doubtful Accounts $8,000 3 The Bad Debt expense for the year is $8,000. Note that if the balance in the Allowance account after this entry results in a net A/R amount that differs materially from its NRV, the % used may need to be changed or the balance sheet method used instead.

26. 26 Uses past collection experience to estimate uncollectible accounts, without identifying specific accounts Focus is to report accounts receivable at its net realizable value –Does not focus on matching bad debt expense to sales Any existing balance in Allowance for Doubtful Accounts is used to calculate the current year’s bad debt expense Can use: Percentage-of-receivables or aged receivable analysis The Balance Sheet Approach

27. 27 Wilson & Co. – Aging Schedule $ 55,000$ 14,000$ 18,000$460,000$547,000 25%20%15%4%Estimated Uncollectible $14,00060,00074,000Manitoba $55,00055,000Freeport 320,000 Brockville $ 18,000$ 80,000$ 98,000Western > 120 Days 91 – 120 Days 61 – 90 Days < 60 Days BalanceCustomer The Balance Sheet Approach: Aged Receivable Analysis

28. 28 Calculate bad debts expense: 460,000 x.04$18,400 18,000 x.15 2,700 18,000 x.15 2,700 14,000 x.20 2,800 14,000 x.20 2,800 55,000 x.25 13,750 55,000 x.25 13,750 Required balance in Allowance $37,650 Cr. less: current balance in Allowance 800 Cr. Bad Debts Expense $36,850* 1 2 To record bad debts expense: Bad Debts Expense *36,850 Bad Debts Expense *36,850 Allowance for Doubtful Accounts 36,850 Allowance for Doubtful Accounts 36,850 The Balance Sheet Approach: Aged Receivable Analysis

29. 29 Comparison of Methods for Estimating Uncollectibles Percentage-of-Sales Matching Sales Bad Debt Expense Income Statement Approach Percentage-of-Receivables (or Aging Method) Net Realizable Value A/R Allowance for Doubtful Accounts Balance Sheet Approach

30. 30 Balance Sheet Presentation Short-term accounts receivable are shown at their net realizable value as follows: Accounts Receivable $ xxx Less: Allow. for Doubtful Accounts xxx Net Realizable Value $ xxx

31. 31 Allowance Method: Writing Off Accounts Receivable When a specific customer’s account is determined to be uncollectible, the following entry is made: Dr. Allowance for Doubtful Accounts x Cr. Accounts Receivable – specific customer x (for the amount to be written off) If payment is received after write-off of account, the account is reinstated and payment is recorded: Dr. Accounts Receivable Cr. Allowance for Doubtful Accounts Dr. Cash Cr. Accounts Receivable (for the amount collected)

32. 32 Direct Write-off Method If uncollectible amounts are not material, the allowance method is not required Instead, direct write-off method can be used Record bad debt expense only when specific account is determined to be uncollectible: Dr. Bad Debt Expensex Cr. Accounts Receivablex No allowance account is used

33. 33 Recognition of Short-Term Notes Receivable Notes receivable differ from accounts receivable as they are supported by a promissory note (with specific terms) All notes contain some interest Notes are either: –Interest bearing Have a stated rate of interest or –Zero-interest bearing (or non-interest bearing) Interest rate not always stated Interest amount is the difference between the amount borrowed and the face amount

34. 34 Interest Bearing Short-Term Notes Receivable Example: On March 14, 2008, Accounts Receivable of $1,000 is exchanged for a 6% six-month note March 14, 2008 (when note is issued): Notes Receivable1,000 Accounts Receivable1,000 September 14, 2008 (on collection of note): Cash1,030 Notes Receivable1,000 Interest Income 30 Interest = $1,000 x 6% x 6/12

35. 35 Non-Interest Bearing Short-Term Notes Receivable On February 23, 2008, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate On issuance of note: Notes Receivable4,717 Cash4,717* *5,000 / (1 + 6%); 8% x 9/12 = 6% On collection of note: Cash5,000 Notes Receivable4,717 Interest Income 283 Interest = $4,717 x 8% x 9/12

36. 36 Long-term Loans Receivable Long-term loans receivable are recognized at fair value – i.e. the present value of the future cash flows –When the stated interest rate is the same as the market interest rate, the note or loan is issued at its face value –When there is a difference between interest rates, the note or loan is issued at a premium or a discount (i.e. the present value is greater or less than the face value)

37. 37 Long-term Loans Receivable – Interest Bearing Notes Example: Morgan Corp. issues a $10,000, 10% three-year note; market interest rate is 12% and annual interest payments are $1,000 (10% x $10,000) In calculating the note’s present value, use 12% market rate to discount all future cash flows as follows: ($10,000 x.71178) + ($1,000 x 2.40183) = $9,520 The note is issued at a discount (as proceeds < face) Journal Entry at issuance of note: Dr. Notes Receivable 10,000 Cr. Discount on Notes Receivable 480 Cr. Cash 9,520

38. 38 Long-term Loans Receivable – Interest Bearing Notes Example continued: At date of issue, the company has an unamortized discount of $480 (to be amortized over the 3 years) The discount represents interest income to be recognized over the 3 year life of the note $9,520 x 12% = $1,142 (first year interest income) Journal Entry to record first $1,000 interest received: Dr. Cash 1,000 Dr. Discount on Notes Receivable 142 Cr. Interest Income 1,142

39. 39 Long-term Loans Receivable – Interest Bearing Notes Example continued Book value of Notes Receivable is now: $10,000 – ($480 - $142) = $9,662 Interest Income for second year: $9,662 × 12% = $1,159 Journal Entry to record second $1,000 interest received: Dr. Cash1,000 Dr. Disc. on Notes Receivable 159 Cr. Interest Income 1,159

40. 40 The holder of accounts or notes receivable may transfer them to another company for cash The transfer may be: – A secured borrowing – A sale of receivables Holder retains ownership of receivables in a secured borrowing transaction; the receivables are used as collateral Holder transfers ownership of receivables in a sale Under IFRS, an entity removes a financial asset from its balance sheet when: –its contractual rights to the asset’s cash flows expire; –it has transferred the asset and substantially all the risks and rewards of ownership; or –it has transferred the asset and has retained some substantial risks and rewards of ownership, but the other party may sell the asset. The risks and rewards retained are recognized as an asset. The criteria for de-recognition differs - Canadian GAAP focuses on legal isolation and surrender of control, as opposed to the risk/reward transfer. In addition, Canadian GAAP does not permit partial de-recognition. Disposition of Accounts and Notes Receivable

41. 41 Transfer of Receivables: Borrowing vs. Sale Treatment Conditions 1. Are transferred assets isolated from transferor? and from transferor? and 2. Does transferee have right to pledge or sell the assets? and pledge or sell the assets? and 3. Transferor does not maintain control of the assets through control of the assets through repurchase agreement? repurchase agreement? Yes Sale No SecuredBorrowing

42. 42 Accounting for Transfers of Receivables Secured Borrowing Sale Transfers Continuing involvement by seller No continuing involvement by seller Use components approach: 1. Reduce receivables, 2. Recognize component assets and liabilities, 3,Record gain/loss 1. Reduce receivables, 2. Record gain/loss

43. 43 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 the note periodically from collections

44. 44 Sale of Receivables (e.g., Factoring) Ownership of receivables transferred to the purchaser (the factor); receivables recorded as an asset in the purchaser’s books If sold without recourse, purchaser is fully responsible for collections of the receivables Seller records any retained proceeds as “due from factor” (a receivable) which covers possible sales discounts and sales returns and allowances Seller records loss on sale of receivables (basically the finance charge) Seller records any recourse liability (if receivables are sold with recourse i.e., seller’s guarantee)

45. 45 Presentation of Trade Accounts and Notes Receivable Segregate types of receivables (i.e. ordinary trade accounts, due from related parties and other receivables segregated) If > 1 year, report amount and maturity date If < 1 year, report in current assets Disclose if receivables pledged as collateral for liabilities Use allowance account to record impairments

46. 46 For Loans and Receivables that are Financial Instruments Provide specific information about: The significance of loans and receivables to a company’s financial position and performance, and The nature and extent of risks arising from these assets

47. 47 International Comparison – Loans and Receivables Canadian and international GAAP are substantially converged Some differences still exist related to transaction costs, related party transactions, and derecognition, for example

48. 48 Analysis Accounts Receivable Turnover: Net Sales/Revenue Average Trade Receivables (Net) Days Sales Uncollected: 365 Days A/R Turnover

49. 49 Current IFRS GAAP Comparisons Main differences: Under IFRS some equity instruments can be classified as cash equivalents. For example, preferred shares acquired within a short time of their maturity and with a specified redemption date. Under IFRS, an entity removes a financial asset from its balance sheet when: –its contractual rights to the asset’s cash flows expire; –it has transferred the asset and substantially all the risks and rewards of ownership; or –it has transferred the asset and has retained some substantial risks and rewards of ownership, but the other party may sell the asset. The risks and rewards retained are recognized as an asset. The criteria for de-recognition differs under Canadian GAAP. Canadian GAAP focuses on legal isolation and surrender of control, as opposed to the risk/reward transfer. In addition, Canadian GAAP does not permit partial de-recognition.

50. Looking Ahead The IASB is working on several projects addressing the ‘re-recognition’ of financial assets and liabilities 50

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