Wacky Warning Labels (from

Wacky Warning Labels (from www.wackywarnings.com)
A warning on an electric drill made for carpenters’ cautions: “This product not intended for use as a dental drill” The label on a bottle of drain cleaner warns: “If you do not understand, or cannot read, all directions, cautions and warnings, do not use this product” A smoke detector warns: “Do not use the Silence Feature in emergency situations. It will not extinguish a fire.” A cardboard car sunshield that keeps sun off the dashboard warns, “Do not drive with sunshield in place” An “Aim-n-Flame” fireplace lighter cautions, “Do not use near fire, flame or sparks” A label on a hand-held massager advises consumers not to use “while sleeping or unconscious” A snowblower warns: “Do not use snowthrower on roof”

Chapter 7 CASH AND RECEIVABLES Sommers – Intermediate I
Acct Class 24 Chapter 7 CASH AND RECEIVABLES Sommers – Intermediate I Chapter 1: Environment and Theoretical Structure of Financial Accounting.

Reporting Cash Bank Overdrafts
Company writes a check for more than the amount in its cash account. Generally reported as a current liability. Offset against other cash accounts only when accounts are with the same bank.

Accounts Receivable Receivables - Claims held against customers and others for money, goods, or services. Oral promises of the purchaser to pay for goods and services sold. Written promises to pay a sum of money on a specified future date. Accounts Receivable Notes Receivable

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.).

Trade Discounts Reductions from the list price
Not recognized in the accounting records Customers are billed net of discounts

Cash (Sales) Discounts
Inducements for prompt payment Gross Method vs. Net Method Payment terms are 2/10, n/30

Sales and Trade Discounts
Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 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, /17 Accounts receivable 42,000 Sales 42,000 11/26 Cash 41,160 Sales discounts 840 Accounts receivable 42,000

Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 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, /17 Accounts receivable 42,000 Sales 42,000 12/15 Cash 42,000 Accounts receivable 42,000

Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 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, /17 Accounts receivable 41,160 Sales 41,160 11/26 Cash 41,160 Accounts receivable 41,160

Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 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, /17 Accounts receivable 41,160 Sales 41,160 12/15 Cash 42,000 Accounts receivable 41,160 Interest income 840

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.

Allowance for Doubtful Accounts
Recognition of A/R How are these accounts presented on the Balance Sheet? Allowance for Doubtful Accounts Accounts Receivable Beg Beg. End End.

Recognition of A/R

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.

Direct Write-Off vs. Allowance Method
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. Allowance Method Losses are Estimated: Percentage-of-sales. Percentage-of-receivables. GAAP requires when material in amount.

Percentage of Sales vs. Receivables
Emphasis on the Income Statement relations Emphasis on the Balance Sheet relations

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.

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) ,000 Credit sales for ,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? $1,750,000 * 2% = $35,000 Bad debt expense 35,000 Allowance for bad debts 35,000

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.

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) ,000 Credit sales for ,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? $900,000 * 5% = $45,000 as ending ABD balance Bad debt expense 29,000 Allowance for bad debts 29,000 (45,000 – 16,000)

A/R Aging Adjustment Bad Debt Expense 36,850
What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment? Bad Debt Expense 36,850 Allowance for Bad Debts ($37,650 – $800) 36,850

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 Group Amount % Uncollectible 0-60 days $430,000 4% days 98,000 15% 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.

Bad Debt Problem Bad debt expense (3% x $2,620,000) 78,600
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 Bad debt expense (3% x $2,620,000) 78,600 Allowance for uncollectible accounts 78,600 Allowance for uncollectible accounts 68,000 Accounts receivable 68,000

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 Group Amount % Uncollectible 0-60 days $430,000 4% days 98,000 15% days 60,000 25% Over 120 days 55,000 40% Totals $643,000 Prepare the necessary year-end adjusting entry for bad debt expense.

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 Group Amount % Uncollectible Allowance 0-60 days $430,000 4% $17, days 98,000 15% 14, days 60,000 25% 15,000 Over 120 days 55,000 40% 22,000 $68,900 ABD 54,000 78,600 68,000 ? Solve for Bad Debt Expense 68,900 Bad debt expense 4,300 Allowance for bad debts 4,300

Bad Debt Problem What is total bad debt expense for 2011? Monthly accruals $78,600 Year-end adjustment 4,300 Total $82,900 How would accounts receivable appear in the 2011 balance sheet? Current assets: Accounts receivable, net of $68,900 allowance for uncollectible accounts $574,100

Example 2a Sandel Company 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. Bad Debt Expense 7,500 Allowance for Doubtful Accounts 7,500 ($800,000 – $50,000) x 1% = $7,500

Example 2b Sandel Company 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. Bad Debt Expense 6,000 Allowance for Doubtful Accounts 6,000 [($160,000 x 5%) – $2,000] = $6,000

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? 50 50

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, The entry to record the write-off is: Allowance for Doubtful Accounts 1,000 Accounts Receivable 1,000 Assume that on July 1, Randall Co. pays the $1,000 amount that Brown had written off on March 1. These are the entries: Accounts Receivable 1,000 Allowance for Doubtful Accounts 1,000 Cash 1,000 Accounts Receivable 1,000 LO 5

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, 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 30,000 Sales revenue 30,000

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, The 6% rate is appropriate in this situation. Prepare the journal entry at December 31, December 31, 2011 Interest receivable 900 Interest revenue 900 ($30,000 x 6% x 6/12) = 900

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, The 6% rate is appropriate in this situation. Prepare the journal entry at March 31, March 31, 2012 Cash 31,350 Interest revenue 450 Interest receivable 900 Note receivable 30,000 ($30,000 x 6% x 3/12) = 450

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

Illustration: How does Morgan record the receipt of the note? Notes Receivable 10,000 Discount on Notes Receivable 480 Cash 9,520

Illustration 7-15

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”?
Imputed interest is the interest ascribed or attributed to a situation or circumstance which is void of a stated or otherwise appropriate interest factor. Imputed interest is the result of a process of interest rate estimation called imputation. In what situations is it necessary to impute an interest rate for notes receivable? An interest rate is imputed for notes receivable when (1) no interest rate is stated for the transaction, or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the note is materially different from the current cash price for the same or similar items or from the current market value of the debt instrument.

Discussion Question Q7-15 Continued – What are the considerations in imputing an appropriate rate? In imputing an appropriate interest rate, consideration should be given to the prevailing interest rates for similar instruments of issuers with similar credit ratings, the collateral, and restrictive covenants.

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, 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). FV=40,000, pmt=0, n=5, i=6% => PV=29,890 April 30, 2011 Note receivable 40,000 Discount on note receivable 10,110 Sales revenue 29,890

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, 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

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, 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 - 1,793 31,683 4/30/2013 4/30/2014 4/30/2015 4/30/2016

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, 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 - 1,793 31,683 4/30/2013 1,901 33,584 4/30/2014 4/30/2015 4/30/2016

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, 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 - 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

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, A 6% interest rate is appropriate in this situation. Prepare the journal entry at December 31, December 31, 2011 Discount on note receivable 1,195 Interest revenue 1,195 (1,793 X 8/12) 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

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, A 6% interest rate is appropriate in this situation. Prepare the journal entry at December 31, December 31, 2012 Discount on note receivable 1,865 Interest revenue 1,865 (1,793 X 4/12) + (1,901 X 8/12) 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

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, A 6% interest rate is appropriate in this situation. What is the balance of the note at December 31, 2012? 31,683 + (1,901 X 8/12) = 32,950 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

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, A 6% interest rate is appropriate in this situation. Prepare the journal entry at April 30, April 30, 2016 Discount on note receivable 755 Interest revenue 755 (2,265 X 4/12) Cash 40,000 Note receivable 40,000 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: ($35,247 - $20,000) = $15,247 Notes Receivable 35,247 Discount on Notes Receivable 15,247 Land 14,000 Gain on Sale of Land 6,000

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? The fair value option gives companies the option of using fair value as the measurement basis for financial instruments. The Board believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost. If companies choose the fair value option, the receivables are recorded at fair value, with unrealized gains or losses reported as part of net income.

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? The accounts receivable turnover ratio is computed by dividing net sales by average net receivables outstanding during the year. This ratio is used to assess the liquidity of the receivables. It measures the number of times, on average, receivables are collected during the period. It provides some indication of the quality of the receivables and how successful the company is in collecting its outstanding receivables.

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.

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