FIN Chapter 7 - Cash and Receivables Cash and Cash...

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Unformatted text preview: Cash and Receivables Cash and Cash Equivalents Cash includes currency, coins, checking Cash accounts, savings accounts accounts, Cash equivalents include money market Cash funds, treasury bills, commercial paper funds, – Must have a maturity < 3 months from the Must date of purchase date – Credit and debit card receivables are often Credit included in cash equivalents included – Must be disclosed in footnotes Apple’s Footnotes Internal Control Sarbanes-Oxley requires a company to document and Sarbanes-Oxley assess the effectiveness of its internal control procedures. procedures. – Auditors are required to express an opinion on management’s Auditors assessment. assessment. Internal control refers to a company’s plan to – – – Encourage adherence to company policies and procedures Promote operational efficiency Minimize errors and theft Cash is the asset that is most at risk for theft – Enhance the reliability and accuracy of accounting data Internal Control Framework for internal control developed by Framework Committee of Sponsoring Organizations (COSO) Committee – Internal Controls are processes designed to provide Internal reasonable assurance regarding reasonable Effectiveness and efficiency of operations Reliability of financial reporting Compliance with applicable laws and regulations Key internal control – Separation of Duties – Employees involved in recordkeeping should not have Employees physical access to assets physical Restricted Cash Restrictions on cash – restricted cash Restrictions should be classified as Investments should Sinking funds – contractual obligation to Sinking set aside cash to repay debt set – If debt is current, then sinking fund should be If classified as current asset classified – If debt is noncurrent, then sinking fund should If be classified as Investments be Compensating Balance Compensating Balance – contractual Compensating obligation associated with a loan or line of credit credit – Requires that a percentage of the loan Requires balance be kept in a bank account with the creditor creditor – Results in a higher effective interest rate on Results the debt the Material amounts of restricted cash or Material compensating balances must be disclosed compensating Current Receivables Receivables represent a company’s claims to Receivables the future collection of cash, other assets, or services. services. Accounts Receivable - result from the sale of Accounts goods or services on account (trade receivables) goods Nontrade Receivables – receivables other than Nontrade trade receivables trade – Include tax refund claims, interest receivable, and Include loans made by the company to other entities loans Apple’s Nontrade Receivables Accounts Receivable Current assets Revenue and the related receivables are Revenue usually recognized at the point of delivery of the goods or service of Normally due within 30 to 60 days Non-interest bearing Initial Valuation of Accounts Receivable Accounts Receivable are valued at the Accounts amount to be received amount Because of their short duration – no need Because to consider time value of money (interest is immaterial) is Trade Discounts Represents the percentage discount due Represents to the item being “on sale” to Avoids frequent production of price lists May also be quantity discounts to May important customers important Revenues and related receivables are Revenues recorded “net” of the trade discount recorded Cash Discounts Cash discounts (also called sales discounts) are Cash reduction in selling price if the customer pays their account within a specified time period their – Provides an incentive for quick payment Terms are often stated as: % Discount/If paid Terms within this many days from purchase date, net/Must be paid this many days from purchase date date – Example: 4/15, n/45 Cash Discounts Two allowable methods for recording cash Two discounts: gross method or net method discounts: – Gross method views cash discounts not taken Gross as part of sales revenue as Most commonly used – Net method considers cash discounts not Net taken as interest revenue taken More theoretically correct Cash Discounts At time of sale: Dr. A/R Cr. Sales Revenue – Amount is before discount is considered if Amount gross gross – At discounted amount if net (assumes cash At discount will be taken) discount Cash Discounts If cash is paid within the Discount period: – Gross: Dr. Cash (Discounted Amount) Dr. Sales Discounts (Amount of Dr. Discount) (Contra Revenue account) Discount) Cr. A/R (Full or Gross Amount) – Net: Dr. Cash (Discounted Amount) Cr. A/R (Discounted Amount) Cash Discounts If cash is pad after discount period If expires: expires: – Gross: Dr. Cash (Full or Gross Amount) Cr. A/R (Full or Gross Amount) – Net: Dr. Cash (Full or Gross Amount) Cr. A/R (Discounted Amount) Cr. Interest Revenue or Discounts Not Cr. Taken (Amount of Discount) Taken E7­3, p. 360 Work in class Subsequent Valuation of Accounts Receivable Accounts receivable could be less than Accounts the gross amount recorded for two possible reasons possible – Customer returns goods – Customer could default and not pay amount Customer owed (i.e., bankruptcy) owed Sales Returns Merchandise could be returned for refund or new Merchandise product product – Sales return for cash or credit: Dr. Sales Returns and Allowances Cr. Cash or A/R – If perpetual method is used, must also record If returned merchandise in inventory: returned – No entry needed when sales return for new No merchandise; however if old merchandise was defective, it may need to be impaired (cover in upcoming inventory chapters) upcoming Dr. Inventory (at cost) Dr. Cost of Goods Sold (at cost) Sales Returns Timing Issue – if return occurs in the Timing period after the sale, the prior period’s revenue is overstated revenue If sales returns are material, in order to If achieve proper matching, they should be estimated and recorded in the time period of the original sale of – Allowance for Sales Returns – contra A/R Allowance account account Sales Returns Sales are recorded in regular way Adjusting entry at the end of the accounting Adjusting period to estimate Sales Returns: period Dr. Sales Returns and Allowances Cr. Allowance for Sales Returns Also must adjust COGS and Inventory if Also perpetual method is used: perpetual Dr. Inventory – Estimated Returns (at cost) Cr. Cost of Goods Sold (at cost) E7­6, p. 360 Work in class Uncollectible Accounts Receivable Use an allowance method to achieve matching Use of sales revenue with expense (Bad Debt Expense) Expense) – Allowance for Doubtful Accounts (Allowance for Allowance Uncollectible Accounts) – contra A/R account Uncollectible Bad Debt Expense is cost of granting credit Accounts receivable need to be reported at their Accounts Net Realizable Value (NRV) – the amount of cash expected to be realized cash Uncollectible Accounts Receivable Balance Sheet Presentation: – Net Realizable Value = Gross A/R minus Net Allowance for Doubtful Accounts Allowance Can use the Income Statement or Balance Can Sheet approach to estimate bad debts Sheet Income Statement Approach Amount of bad debts are estimated as a Amount percentage of net credit sales percentage At the end of the accounting period, need At the following adjusting entry: the Dr. Bad Debt Expense Cr. Allowance for Doubtful Accounts Balance Sheet Approach Amount of bad debts are estimated as the Amount amount needed to achieve a desired amount in the Allowance account. amount – Can apply a single percentage to all A/R or Can use an aging analysis to compute varying percents based on delinquency. percents – Higher percentages are expected to be Higher uncollectible the older the balance is. uncollectible Balance Sheet Approach Computation determines the amount that Computation should be in the Allowance for Doubtful Accounts after the adjustment (the ADA ending balance) ending – The amount of the adjusting entry is whatever The value is needed to achieve the ending ADA balance that is determined by the percentage computation. computation. Dr. Bad Debt Expense Cr. Allowance for Doubtful Accounts Adjusting Entries are Based on Estimates Will not be the exact amount of Will uncollectible accounts uncollectible – At the end of the period (before the current At year’s bad debts adjustment), the amount remaining in the Allowance for Doubtful Accounts is the estimation error Accounts – Can have either a debit or credit balance Has implications for computations using the Has Balance Sheet method Balance When Accounts are Deemed Uncollectible Bad Debts expense is an adjusting entry Bad at the end of each accounting period. at However, all throughout the accounting However, period, the credit department judges individual accounts to be worthless. individual This “housekeeping” function needs to be This recorded in journal entries in order to remove the delinquent accounts from A/R. remove When Accounts are Deemed Uncollectible To remove individual accounts, the following To entry is made: entry Dr. Allowance for Doubtful Accounts Cr. A/R Do these individual account writeoffs affect the Do net realizable value of A/R? net – No, because NRV = A/R minus Allowance for No, Doubtful Accounts Doubtful – Notice, you’re subtracting a constant from both A/R Notice, and the ADA, so the NRV remains unchanged. and When Previously Written Off Accounts are Collected Occasionally, an account that has been written Occasionally, off is ultimately collected. Dr. A/R Cr. Allowance for Doubtful Accounts – When this happens, the first step is to re-establish the When A/R by reversing the write-off entry: A/R However, the amount of this reinstatement should only be However, the amount received because there is no guarantee the delinquent customer will continue to pay on their account. delinquent – Next, an entry to record the receipt of cash is made: Dr. Cash Cr. A/R – Do not combine entries – it destroys the “audit trail” Do for the transaction. for E7­8, p. 360 Work in class Direct Write­Off of Uncollectible Accounts It cannot reasonably estimate bad debts or It if they are immaterial, may use the direct write-off method for each delinquent account: account: Dr. Bad Debt Expense Dr. Cr. A/R Cr. This method must be used for income tax This purposes. purposes. E7­7, p. 360 Work in class Apple’s Footnotes Notes Receivable Accompanied by a formal promissory note Often interest-bearing May be trade or nontrade receivable May be current or noncurrent May (Investments) (Investments) Interest­Bearing Notes Requires payment of face amount Requires (principal) and interest (principal) – Interest = Face Amount x Annual Rate x Interest Fraction of Year Fraction To record N/R received as payment for To goods: goods: Dr. Note Receivable (Face Amount) Cr. Sales Revenue Interest­Bearing Notes If interest payment is received before end of the If accounting period, the entry to record the interest is: interest Dr. Cash Cr. Interest Revenue If interest payment is not due until after the If period-end, an adjusting entry must be made to accrue interest through the end of the reporting period: period: Dr. Interest Receivable Cr. Interest Revenue Interest­Bearing Notes Then in the next period, when the interest is actually Then received in cash: received Dr. Cash Cr. Interest Receivable – Notice the income statement effect occurred in the prior period Notice (matching) (matching) When the note is repaid, the amount of cash received When includes the face amount plus any unpaid interest. includes – The entry, assuming that some interest had been accrued in The prior periods is: prior Dr. Cash (Face Amount plus interest) Cr. Note Receivable (Face Amount) Cr. Interest Receivable (for interest accrued in prior periods) Cr. Interest Revenue (for interest accrued since the last adjusting Cr. entry) entry) E7­11, p. 361 Work in class Noninterest­Bearing Notes Some businesses offer “interest-free” loans as Some an inducement for customers to buy their products. products. Because of the time value of money, all notes Because (interest- or non-interest bearing) have an implicit “charge” for the use of money. implicit – Therefore, the face amount of the note contains a Therefore, portion that is for the underlying good (sales revenue) and a portion that is interest. and – If the entire face value of the note was recorded as If sales revenue, sales (operating) revenue would be overstated. overstated. Noninterest­Bearing Notes At the time of the sale: Dr. Note Receivable (Face Amount = Amount for Goods Dr. + Amount for Interest) Amount Cr. Sales Revenue (Amount for Goods) Cr. Discount on Notes Receivable (Amount for Interest) Cr. (contra-asset account) (contra-asset In some cases, the amount for goods (the fair In value) may be known and objective. If not, we may need to solve for the Discount If using present value techniques and let the Sales Revenue be the difference between the face amount of the N/R and the Discount. amount Noninterest­Bearing Notes Need the following information to compute the Need discount: face value of the N/R, effective interest rate, and the term of the note. rate, – PV of the N/R = Face Amount multiplied by Present PV Value Factor Value – In some cases, the N/R terms may specify a series of In payments in which case: payments PV of the N/R = Periodic Payment multiplied by Present PV Value of Annuity Factor Value PV of the N/R = Sales Revenue Noninterest­Bearing Notes Carrying Value of the N/R = Face Amount of N/R Carrying minus balance in the Discount on N/R account. minus Over time, the Discount on N/R is converted to Over interest revenue over the life of the note: interest – Determine the amount of the interest revenue earned Determine by using the effective interest rate method: by Interest Revenue = Carrying Value of N/R multiplied by Interest Effective Annual Interest Rate multiplied by Fraction of Year Outstanding Outstanding Dr. Discount on N/R Cr. Interest Revenue Noninterest­Bearing Notes When the N/R is paid, the customer doesn’t When realize there was an interest component and they simply pay the face amount in cash: they Dr. Cash (Face Amount) Cr. Note Receivable (Face Amount) May need an entry to accrue interest since the May last period-end last At end of N/R life, the Discount on N/R should At have been reduced to zero through the recognition of interest revenue. recognition E7­12, p. 361 Work in class Imputed Interest Example: Assume that ABC Co. surveyed 800,000 acres of mountain property for the M ountain M eadow Ranch. O n December 31, 1999, ABC accepted a $45,000 note as payment for services. The note is non-interestbearing and comes due in three yearly installments of $15,000 each, beginning D ecem ber 31,2000. Assume there is no market for the note and no basis for estimating objectively the FM V of the s ervices rendered. After considering the current prim e interest rate, the credit standing of the ranch, t he collateral available, the terms for repayment, and the prevailing rates of interest for the issuer's other debt, a 10% imputed interest rate is considered appropriate. The computations are: Face amount of note Less present value of note: P V = P aym ent x Present Value of an A nn. F actor (n= 3, i=.10) Discount on note * $ 15,000 x 2.4869 = $37,304 $45,000 37,304 * $ 7,696 The entry to record receipt of the note would be: 12/31/1999 Notes receivable D iscount on notes receivable S ervice revenue 45,000 7,696 37,304 A sc he dule show ing the am ortiza tion of the discount on the note is pre sented below . This type of c om putation is com m only referred to as the effec tive intere st am ortization m ethod. (1 ) (2) (3) (4) (5) Face A m ount Net D isc ount B efore Curr. U nam ort. A m ount A m ort. P aym ent Insta llm ent D iscount (1) - (2) (3) x 10% R ec eived D ec. 31, 2000 $ 45,000 $ 7 ,696 $ 3 7,304 $ 3 ,730 $ 1 5,000 D ec. 31, 2001 30,000 3 ,966 2 6,034 $ 2 ,603 1 5,000 D ec. 31, 2002 15,000 1 ,363 1 3,637 $ 1 ,363 1 5,000 $ 4 5,000 The e ntry at D ecem ber 31, 2000 to record rece ipt of the pa ym e nt w ould be: 12/31/2000 C ash D iscount on notes rece iva ble I nte rest revenue N ote s rec eivable 15,000 3,730 3,730 15000 A t th e end of the 3 yea rs, the disc ount w ill be com plete ly am ortize d to interest revenue, the fa ce a m ount of the note rec eivable w ill have been c olle cted, a nd the appropriate am ount of servic e revenue w ill have been re cognize d in the year it w a s earne d. A t the end of ea ch ye ar, the balance sheet w ill re flec t the net present value of the rece iva ble by subtra cting the una m ortize d disc ount balance from the o utstanding b alance in N otes R ece iva ble . Notes Received Solely for Cash Amount of Cash Paid is its present value: Dr. N/R (Face Amount) Cr. Cash (Amount Given) Subsequent Valuation of Notes Receivable Bad debts are estimated for N/R just as Bad they are for A/R. they Notes must be presented at their NRV on Notes the balance sheet. the When it becomes unlikely that all or part of When the note will be uncollectible, it is impaired or written-off entirely. or Financing with Receivables Can use receivables as collateral for a loan (secured Can borrowing, assignment or pledging) or sell them outright (factoring or securitization) (factoring – Qualifies for a sale (factoring or securitization) only if transferor Qualifies has surrendered control over the assets transferred. has – Surrender of control is true only if all of the following conditions Surrender are met: are Transferred assets are isolated from the transferor (beyond the Transferred reach of the transferor’s creditors) reach Transferee has the right to resell or pledge them to another party Transferor does not maintain effective control through repurchase Transferor agreement or callability agreement – If these conditions are not met, then transfer is treated as a If secured borrowing and transferor must record a liability for the amount of cash received from the transferee. amount Secured Borrowing Also called assigning receivables Must assign more receivables than the amount Must of cash received (in case of sales returns and/or uncollectible accounts) uncollectible Transferee (assignee) will assess a finance Transferee charge for the right to assign the receivables. charge Either party can be responsible for collecting Either payments (specified at time of contract) payments Secured Borrowing When the cash is received from the bank or When transferee: transferee: Dr. Cash (Amount of Liability less the finance charge) Dr. Finance charge (specified by the contract) (an Dr. expense) expense) Cr. Liability or N/P (specified by the contract) If the customers still make their payments to the If transferor, then when the transferor receives the customer payments, the journal entry is: customer Dr. Cash Cr. A/R Secured Borrowing When the transferor makes periodic When collection payments to the transferor (to pay off the liability and interest), the entry is: is: Dr. Liability (Amount of payment due – Dr. usually amount collected from customers) customers) Dr. Interest Expense (Liability x Interest Dr. Rate x Fraction of Year Outstanding) Rate Cr. Cash (Amount collected from Cr. customers plus interest on loan) customers Secured Borrowing Balance Sheet Presentation: – Cannot claim entire A/R because a portion is promised as Cannot collateral against the outstanding loan. – Instead, we report the balance of assigned A/R and its related Instead, liability separately as follows: liability Accounts Receivable – Assigned Less: Liability Equity in A/R – Assigned $XXXX (XXXX) $XXXX – In this case, we are allowed to net a liability against an asset, In because those assets are set aside specifically to repay that liability. liability. – Arrangements must be disclosed in footnote. – If specific A/R are not designated, but instead a dollar value of A/ R are used as collateral, this is referred to as “pledging”. Only are footnote disclosure is needed for pledging. footnote E7­14, p. 361 Work in class Sale of Receivables Can be structured as a: – Factoring Financial institution (the factor) buys receivables for cash, handles Financial the billing, and collection of receivables and charges a fee (usually 3 to 6 percent) for this service. to Seller relinquishes all rights to future cash receipts in exchange for Seller cash from buyer (factor) cash Factor will retain a portion of the cash from the seller to make sure Factor receivables are ultimately collected (no sales returns or uncollectible accounts). accounts). – Securitization Company creates a special purpose entity (SPE) to buy receivables Company from the company. SPE then sells the receivables (in packages) to other investors other – The accounting for factoring and securitizations depends on The whether or not the receivables are sold without or with recourse. whether Sale without Recourse The buyer assumes the risk of uncollectibility The and has no “recourse” if the customers do not pay their accounts. pay When receivables are sold, seller makes the When following entry: following Dr. Cash (A/R sold less amount retained to cover bad Dr. debts and sales returns) debts Dr. Receivable from Factor (Amount retained less any Dr. fees charged by the factor) fees Dr. Loss on sale of receivables (Factor’s fee) Cr. A/R (amount of A/R sold) E7­15, p. 361 Work in class Sale with Recourse Seller retains risk of uncollectibility which means that Seller seller provides guarantee that A/R will be collectible. seller – Seller must record the fair value of this recourse obligation as a Seller liability (which will increase the loss on the sale). liability When receivables are sold, seller makes the following When entry: entry: Dr. Cash (A/R sold less amount retained to cover bad debts and Dr. sales returns) sales Dr. Receivable from Factor (Amount retained less any fees Dr. charged by the factor) charged Dr. Loss on sale of receivables (Factor’s fee plus fair value of Dr. recourse liability) recourse Cr. Recourse Liability (fair value of recourse liability) Cr. A/R (amount of A/R sold) E7­16, p. 362 Work in class Discounting a Note When notes are sold for cash, this process is called When “discounting” “discounting” Several steps to discounting a N/R: – Accrue interest revenue on N/R just prior to selling the note. – Compute maturity value of the N/R = Face amount of N/R plus Compute the remaining interest to be earned on the note till maturity the – Deduct the discount (fee) needed to sell the note = Maturity Deduct Value of N/R multiplied by bank’s discount rate multiplied by Fraction of Year remaining until Note’s maturity. Fraction – Cash Proceeds on the N/R = Maturity Value minus Discount Discounting a Note The journal entry to record the sale of the The N/R: N/R: Dr. Cash (cash proceeds above) Dr. Loss on sale of N/R (plug) Cr. N/R (face amount) Cr. Interest Receivable (accrued interest Cr. from first step above) from E7­17, p. 362 Work in class Bank Reconciliation Books (GL amount) Plus: Receipts Receipts Notes collected Notes Interest earned Interest Errors Less: Disbursements Disbursements NSF checks Service charges Bank fees Bank Errors Errors **End Balance of cash **End Bank statement (end of period) Bank Plus: Deposits in transit Errors Less: Less: Outstanding Checks Errors **End Balance of Cash **End **The above figures should agree = “True” Cash Bank Reconciliation Hoobastank Inc. March 31, 2008 Balance per bank.... $4,135 Balance per books.............. $3,950 Additions to bank Additions to book balance: balance: Deposits in transit.... 500 Direct deposit...................... 450 Total................... $4,635 Interest................................ 71 Total............................... $4,471 Deductions from bank balance: Deductions from book Outstanding checks: balance: 191....... $251 Service charge.............. $ 7 192....... 125 NSF check.................... 100 195....... 75 (451) Error in recording check 180 (287) Adj. bank balance $4,184 Adj. book balance $4,184 Journal Entries All adjustments made to the Balance per Books need to be recorded: ADDITIONS: Cash..................................................... 521 Accounts Receivable....................... 450 Interest Revenue............................. 71 DEDUCTIONS: Accounts Receivable (NSF)................. 100 Miscellaneous General Expense (SC).. 7 Recording Error, Underwritten check*.. 180 Cash............................................... 287 * Debited to original account. Petty Cash Petty cash is used for small expenditures. Costly to process checks for immaterial Costly amounts. amounts. Petty cash is often kept by person in front Petty office. office. Journal Entry to establish a petty cash Journal fund: fund: Dr. Petty Cash Cr. Cash Petty Cash Then the petty cash custodian pays cash Then out and records expenditures on vouchers which are also stored in the lock box. which Periodically, another party (separation of Periodically, duties) will replenish the petty cash fund. duties) – Total vouchers and assign accounts for the Total various expenditures. various – Replenishment Amount = Original Petty Cash Replenishment Fund Amount minus Total of Vouchers Fund Petty Cash The J/E to record the replenishment: Dr. Postage Expense Dr. Entertainment Expense Cr. Cash What if Vouchers are not equal to amount of What cash missing? cash – Use account called “Cash Over or Short” – Can be either a debit or credit Only time entry to Petty Cash is made Only subsequent to initial entry is to increase or decrease the amount kept in petty cash. decrease E7­22, p. 363 Work in class ...
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This note was uploaded on 04/08/2009 for the course ACG 3481 taught by Professor Dickinson during the Fall '08 term at University of Florida.

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