and Cash Receivables
Chapter 7
Prepared by: Dragan Stojanovic, CA Rotman School of Management, University of Toronto
Cash and Receivables
Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead
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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 3856
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Cash and Receivables
Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead
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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
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Reporting of Cash
Reporting cash needs special attention of the following: 1. 2. 3. 4. Restricted cash Cash in foreign currencies Bank overdrafts Cash equivalents
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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)
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Restricted Cash
If the restricted cash 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
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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
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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
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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.
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Cash and Receivables
Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead
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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
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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 14
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 generally 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
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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
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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 Cash 9,800 DR Sales Discounts 200 CR Accounts Receivable 10,000
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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 Cash 10,000 CR Sales Discounts Forfeited 200 CR Accounts Receivable 9,800
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Impairment 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 Loans and receivables impaired if these is "significant adverse change" in expected configuration of cash flows (i.e. timing or amount)
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Estimating Uncollectible Receivables
The Allowance Method
Records estimated impairment to properly value accounts receivables and record the bad debt losses as 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
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Estimating Uncollectible Accounts
The estimate of uncollectible accounts may be based on: Allowance Procedure Only: management frequently estimates uncollectible amounts and adjusts the Allowance for Doubtful Accounts Mix of Procedures: initially may use percentage of sales (or net sales), but must still adjust at year-end to ensure that Allowance for Doubtful accounts is appropriate Regardless of procedure used, net accounts receivable at year-end must be reported at net realizable value (key focus is on measurement of accounts receivable at net realizable value)
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Allowance Procedure Only
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
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Allowance Procedure Only
Wilson & Co. Aging Schedule
Customer Balance < 60 Days $ 80,000 320,000 $55,000 60,000 $ 18,000 15% $14,000 $ 14,000 20% $ 55,000 25%
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61 90 Days $ 18,000
91 120 Days
> 120 Days
Western Brockville Freeport Manitoba
$ 98,000 320,000 55,000 74,000
$547,000 $460,000 Estimated Uncollectible 4%
Allowance Procedure Only
1 Calculate the impairment and bad debts expense: 460,000 x .04 $18,400 18,000 x .15 2,700 14,000 x .20 2,800 55,000 x .25 13,750 Required balance in Allowance $37,650 Cr. less: current balance in Allowance 800 Cr. Write-down amount for period $36,850*
2 To record the write-down for the period: Bad Debts Expense *36,850 Allowance for Doubtful Accounts
36,850
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Mix of Procedures
Initial use of "percentage-of-sales" approach is based on the relationship between sales and debts bad 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 initially ignored when calculating the current period's bad debts expense Receivables are also reviewed at year-end to ensure that balance is appropriate, and adjustment to Allowance for Doubtful Accounts is made
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Mix of Procedures: Example
Example: Dockrill Corp. reports the following balances for its first year of operations (2011): Net credit sales: $400,000 The company estimates bad debts at 2% of net credit sales Determine estimated bad debts expense for 2011
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Mix of Procedures: Example
1 Estimated Bad Debts Expense: $400,000 x 2% = $8,000 2 To record Bad Debts Expense: Bad Debts Expense $8,000 Allowance for Doubtful Accounts 3
$8,000
At year end, management determines that $9,900 will not be collectible, and that balance of Allowance account year-end adjustments is $7,500: Bad Debt Expense $2,400 Allowance for Doubtful Accounts ($9,900 - $7,500 = $2,400)
$2,400
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Balance Sheet Presentation
Short-term accounts receivable are shown at their net realizable value as follows: Accounts Receivable Less: Allow. for Doubtful Accounts Net Realizable Value $ xxx xxx $ xxx
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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
(for the amount to be written off)
x
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)
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Direct Writeoff 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 Expense x Cr. Accounts Receivable x No allowance account is used
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Recognition of ShortTerm 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 31
Interest Bearing ShortTerm Notes Receivable
Example: On March 14, 2011, Accounts Receivable of $1,000 is exchanged for a 6% six-month note March 14, 2011(when note is issued): Notes Receivable 1,000 Accounts Receivable 1,000 September 14, 2011 (on collection of note): Cash 1,030 Notes Receivable 1,000 Interest Income 30 Interest = $1,000 x 6% x 6/12
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NonInterest Bearing ShortTerm Notes Receivable
On February 23, 2011, a $5,000 nine-month non-interest bearing note is issued; 8% is the implied interest rate On issuance of note: Notes Receivable 4,717 Cash 4,717* *5,000 / (1 + 6%); 8% x 9/12 = 6% On collection of note: Cash 5,000 Notes Receivable 4,717 Interest Income 283 Interest = $4,717 x 8% x 9/12
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Longterm 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)
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Longterm 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 9,520 Cr. Cash
9,520
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Longterm 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. Notes Receivable 142 Cr. Interest Income 1,142
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Longterm 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. Cash 1,000 Dr. Disc. on Notes Receivable 159 Cr. Interest Income 1,159
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Longterm Loans Receivable Interest Bearing Notes
Example continued: Under straight-line method (as opposed to the effective interest rate method), initial discount of $480 is recognized as interest income evenly over 3 years at $480 / 3 years = $160 per year IFRS requires the use of effective interest method of amortization Private entity GAAP does not specify the amortization method
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Derecognition of Receivable
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 Specific standards are still in state of flux, so focus is on key concepts
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Borrowing vs. Sale Treatment: pre 2011 Canadian GAAP
Conditions
1. Are transferred assets isolated from transferor? and 2. Does transferee have right to pledge or sell the assets? and 3. Transferor does not maintain control of the assets through repurchase agreement?
Yes
Sale Secured Borrowing
No
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Accounting for Transfers of Receivables
Transfers
Secured Borrowing
Continuing involvement by seller
Use components approach: 1. Reduce receivables, 2. Recognize component assets and liabilities, 3. Record gain/loss
Sale
No continuing involvement by seller
1. Reduce receivables, 2. Record gain/loss
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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
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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 gain/loss on sale of receivables (normally a loss, representing the finance charge) Seller records any recourse liability (if receivables are sold with recourse i.e., seller's guarantee)
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Cash and Receivables
Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead
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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 Use allowance account to record impairments (IFRS also requires reconciliation of changes in the allowance account during accounting period) Income statement disclosure of interest income, impairment losses, and any reversals of such losses
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Analysis
Accounts Receivable Turnover: Net Sales/Revenue Average Trade Receivables (Net) Days Sales Uncollected: 365 Days A/R Turnover
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Cash and Receivables
Cash What is cash? Reporting cash Summary of cashrelated items Receivables Recognition and measurement of accounts receivable Impairment of accounts receivable Recognition and measurement of shortterm notes and loans receivable Recognition and measurement of longterm notes and loans receivable Derecognition of receivables Presentation, Disclosure, and Analysis of Receivables Presentation and disclosure Analysis IFRS / Private Entity GAAP Comparison Comparison of IFRS and private entity GAAP Looking ahead
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Comparison
Both private entity GAAP and IFRS are in state of flux IFRS generally requires more extensive disclosures
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