Ch07s - Chapter 7 Cash and Recievables Chapter 7 Key Concepts Discuss the components of Cash& Cash Equivalents Discuss Procedures for reporting

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Unformatted text preview: Chapter 7 Cash and Recievables Chapter 7: Key Concepts Discuss the components of Cash & Cash Equivalents. Discuss Procedures for reporting Trade Discounts. Direct Write-off and Allowance Methods. Discuss various Notes Receivable Transactions – Face Value, NonInterest, Interest Bearing Notes. Discuss dispositions of receivables. Accounting 301A-Eiler 2 Defining Cash Cash on the Balance Sheet is defined as Cash plus Cash Equivalents. ◦ ◦ Cash: Currency and coins held, Checks and Money orders received, Bank account balances. Cash Equivalents: Money market funds, Short-term certificates of deposit, Treasury Bills (with original maturities of no longer than three months). Accounting 301A-Eiler 3 Reporting Cash Cash and cash equivalents – Often combined and reported as the first (most liquid) “current asset”. Restricted cash - Cash restricted or “earmarked” for a specific purpose, such as a loan contract that requires the firm to maintain a certain cash balance. ◦ Note: Disclose as a long-term asset if it relates to long-term items (such as payment of L/T debt). Bank Overdrafts – Disclosed as a current liability unless there are other positive-balance cash accounts at the same bank that it can be Accounting 301A-Eiler 4 offset against. Reporting Cash Illustration 7-2 Accounting 301A-Eiler 5 Quick Review: Cash Balance Kraft Enterprises owns the following assets at December 31, 2010: Cash in Bank – Savings Account 68,00 0 Checking Account Balance Cash on Hand 9,300 Postdated Checks Cash Refund Due from IRS 31,40 0 Certificates of Deposit (180day) What 17,000 750 90,000 amount should Kraft report under cash and cash equivalents on the Balance Sheet? __94,300____ Accounting 301A-Eiler 6 Defining and Reporting Receivables Receivables – claims against customers for cash, goods, or services. Reporting – Split into Trade and Nontrade; Both are further split into Current and Noncurrent. ◦ ◦ Trade - Amounts owed by customers for goods purchased or services provided. Nontrade – Amounts owed from various parties; Not related to goods purchased or services provided. Accounting 301A-Eiler 7 Nontrade Receivables: Examples 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: 1. 2. 3. 4. 5. 6. Insurance companies for casualties Accounting 301A-Eiler sustained. a) 8 Receivables Account ◦ Verbal promises of the purchaser to pay for goods and services sold. Normally collectible within 30-60 days. Notes ◦ Receivable Receivable Written promises to pay a certain sum of money at a specified future date. Arise from a variety of transactions (i.e. not just trade) and may be short-term or long-term. Accounting 301A-Eiler 9 Reporting Accounts Receivable Trade Discounts Cash Discounts Non-Recognition of Interest Accounting 301A-Eiler 10 Trade and Cash Discounts Trade Discount - reduction in list price (usually for differential volume). ◦ Receivable is recorded net of trade discounts. Cash Discount (Sales Discounts) – terms offered to induce prompt payment from customers. (e.g. 2/10, n/30). Two Methods: Gross method - Sales discounts are reported as a deduction from sales in the Accounting 301A-Eiler income statement. ◦ 11 Comparison of Gross & Net Methods Net Method: Gross Method: January 1, 2006: January 1, 2006: Dr. A/R (1,000 x .98) 980 Cr. Sales Revenue Dr. A/R 1,00 0 980 Cr. Sales Revenue 1,000 Scenario 1: If paid within discount period January 10, 2006: Dr. Cash 980 Cr. A/R Dr. Cash 980 Dr. Sales Discounts 980 20 Cr. A/R 1,000 Scenario 2: If paid outside discount period on 1/15/06: January 15, 2006: Dr. Cash Cr. A/R Accounting 301A-Eiler January 15, 2006: 1,00 0 Dr. Cash 980 Cr. A/R 1,00 0 1.000 12 Accounts Receivable: Non-recognition of Interest A company should measure receivables in terms of their present value. ◦ Customer is getting credit without being charged interest. The profession specifically excludes from present value considerations “receivables arising from transactions with customers in the normal course of business which are due in customary trade terms not exceeding Accounting 301A-Eiler approximately one year.” 13 Valuation of Accounts Receivable Net Realizable Value Uncollectible Accounts Receivable ◦ ◦ Direct Write-Off Method Allowance Method Income Statement Approach: Percentage-ofSales Balance Sheet Approach: Percentage-ofReceivables Collecting Previously Written-Off Accounts Receivable Accounting 301A-Eiler 14 Valuation of Accounts Receivable Reported ◦ ◦ at net realizable value (NRV). The NRV is the net amount expected to be collected The NRV is gross accounts receivable less estimated non-collectible accounts. Balance Sheet Presentation Accounts Receivable (Gross) Less: Allowance Accounts Receivable, Net Accounting 301A-Eiler $ XXX < $ XXX > $ XXX 15 Comparison of Direct Write-Off and Allowance Methods Direct Write-Off Not based on the matching principle. Allowance Based on the matching principle. Accounts are written off when Estimated bad debts are determined non-collectible. matched against revenue. Appropriate only if amounts are not material Accounting 301A-Eiler Must be followed if amounts are material. 16 Direct Write-Off Method Receivable is written off when management decides it will not be able to collect it. ◦ Reverse the receivable and increase the Bad Debt Expense account. Only acceptable when uncollectible amounts are immaterial. Target decides that it will be unable to collect $500 from Max Stout. Accounting 301A-Eiler 17 Direct Write-Off Method (cont.) What journal entry should Target record? Debit Bad Debt Expense (BDE) A/R – Max stout Accounting 301A-Eiler Credit A L C NI D 500 500 D 18 Allowance Method 1: Percentage-of-Sales Based on relation between sales & bad debts. Emphasis on the Income Statement ◦ How much Bad Debt Expense to record? What percent of sales do the managers think they won’t be able to collect? Calculation: Sales x Bad Debt Percent = Bad Debt Expense Accounting 301A-Eiler 19 Example: Percentage-of-Sales Wilton, Inc. had net sales in 2010 of $1,400,000. At December 31, 2010, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250,000 Debit Allowance for Doubtful Accounts $2,400 Credit If Wilton estimates that 2% of its net sales will be uncollectible, what journal entry is needed to record bad debt expense? Accounting 301A-Eiler 20 Example: Percentage-of-Sales Calculation: 1,400,000 X 0.02 = 28,000 Adjusting Entry: Debit Bad Debt Expense ADA Accounting 301A-Eiler Credit A L C NI 28,000 D 28,000 D 21 Allowance Method 2: Percentage-of-Receivables Based on relation between A/R & Allowance accounts. Emphasis on the Balance Sheet. How much should the ending balance in the Allowance for Doubtful Accounts be? What percent of receivables do the managers think they won’t be able to collect? Calculation: A/R EOY X Bad Debt Percent = ADA, EOY Accounting 301A-Eiler 22 Example: Percentage-ofReceivables Wilton, Inc. had net sales in 2010 of $1,400,000. At December 31, 2010, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250,000 Debit Allowance for Doubtful Accounts $2,400 Credit Now, suppose Wilton estimates that 10% of Accounts Receivable will be uncollectible. What journal entry is needed to record bad debt expense? Accounting 301A-Eiler 23 Example: Percentage-ofReceivables Calculation: 250,000 X 25,000 = 225,000 Adjusting Entry: Debit Bad Debt Expense ADA Accounting 301A-Eiler Credit A L C NI 22,600 22,600 24 Take-Home Example: Percentage-of-Receivables Wilton, Inc. had net sales in 2010 of $1,400,000. At December 31, 2010, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250,000 Debit Allowance for Doubtful Accounts $2,400 Debit Now, suppose Wilton estimates that 10% of Accounts Receivable will be uncollectible. What journal entry is needed to record bad debt expense? Accounting 301A-Eiler 25 Take-Home Example: % Receivables Calculation: x = ADA t-account: Debit Credit 2,400 2. 27,400 Adjusting Entry: Debit Accounting 301A-Eiler 25,000 Credit A L C NI 26 Write-Off Under Allowance Method Target decides that it will be unable to collect $500 from Max Stout. What journal entry should Target record? Debit Credit A L C NI ADA 500 A/R Accounting 301A-Eiler I 500 D 27 Recovery of Bad Debt Recovery ◦ Suppose some money is collected after an account is written-off. Journal ◦ ◦ of Bad Debt Entries: Reverse the previous entry and Record the collection of the cash. Accounting 301A-Eiler 28 Recovery of Bad Debt: Example Max Stout pays $350 to Target. Debit A/R Credit 350 ADA Cash I 350 350 A/R Accounting 301A-Eiler A L C NI D I 350 D 29 Notes Receivable Recognition ◦ ◦ ◦ Issues Note Issued at Face Value Note Not Issued at Face Value (ZeroInterest & Interest-Bearing) Imputed Interest Rate Issues Valuation Issues Accounting 301A-Eiler 30 Notes Receivable Often converted from Accounts Receivable. Can also arise from: ◦ ◦ ◦ Loans to employees and subsidiaries. Sales of property, plant, and equipment. Lending transactions (the majority of notes). Note: Record Long-term Notes Receivable at the PV of future cash flows. Present Value of Principal (Single Sum) + PV of Interest Payments (Annuity or Accounting 301A-Eiler 31 Annuity Due) Valuation of Notes Receivable Short term N/R Record at face value less allowance (i.e. same as A/R) Interest Rates Stated rate = Market (effective) rate Stated rate > Market (effective) rate Accounting 301A-Eiler Stated rate < Market (effective) Long term N/R Record at present value of cash expected to be collected Note Issued at Face Value Premium Discount 32 Notes Issued at Face Value Stated Interest Rate = Market Interest Rate. Journal entry to record receipt of the note: Debit N/R Credit A L C NI xx A/R or cash Adjusting i xx d entry to recognize interest: Cash or Interest Rece Interest Rev Accounting 301A-Eiler Xx i Xx i 33 Notes NOT Issued at Face Value Two ◦ Zero-interest bearing Determine issue price on N/R at the implicit interest rate. ◦ Kinds: Calculate Implicit Rate using Present and Future Values. Use effective interest method to amortize discount or premium to interest revenue. Interest bearing Stated rate does not equal market rate. Determine issue price on N/R at the effective interest rate. Use effective interest method to amortize discount Accounting 301A-Eiler 34 Example: Zero-Interest Bearing Notes Club Soda Inc. purchases a machine from Fruit Juice Ltd. with a list price of $10,000 on January 1, 2009, and Club accepts in return a note payable to Fruit Juice Ltd. for $10,000, non-interest bearing, due on December 31, 2010. The fair value of the machine on January 1 is $7,972. Prepare Fruit Juice Ltd.’s journal entries to record the sale, any adjusting entries, and the entry Accounting 301A-Eiler 35 to record the payment on December 31, Example: Zero-Interest Bearing Notes Step 1: Calculate Implicit Rate FV = 10k PV = 7,972 = 1.25(FVF %,n) n=_2__ 2: Record Journal Entry (1/1/2009): Debit Credit r=12%___ Step N/R 10,000 I Discount on N/R 2,028 Revenue 7972 Accounting 301A-Eiler A L C NI D I 36 Example: Zero-Interest Bearing otes NStep 3: Calculate Amortization of Discount: Interest Revenue Discount Amortized Issue Date Carrying Value of Note $ 7,972 12/31/2009 $ 957 $ 957 $ 8,929 12/31/2010 $ 1,071 $ 1,071 $ 10,000 $ 2,028 $ 2,028 Step 4: Record Adjusting Entry (12/31/2009): Debit Discount on N/R Interest Revenue Accounting 301A-Eiler Credit 957 A L C NI I 957 I 37 Example: Zero-Interest Bearing otes NStep 5a: Record Adjusting Entry (12/31/2010): Debit Discount on N/R Credit 1071 Interest Rev. A L C NI i 1071 i Step 5b: Record Collection of Note (12/31/2010): Debit Credit A L C NI Cash 10,000 N/R Accounting 301A-Eiler I 10,000 D 38 Scenarios: Interest-Bearing Notes NOT Issued at Face Value 1: Market rate = Stated rate Debit Notes Receivable Credit A L C NI Face Value Cash, Sales, etc. Face Value 2: Market rate > Stated rate (issued at a discount) Notes Receivable Face Value I Discount on N/R Face Value - PV D Cash, Sales, etc. PV I 3: Market rate < Stated rate (issued at a premium) Notes Receivable Face Value Premium on N/R Face Value - PV Cash, Sales, etc. Accounting 301A-Eiler PV 39 Practice Problems Emphasis Accounting 301A-Eiler on Scenario 2 40 Notes Receivable: Fair Value Option Short-Term ◦ Reported at Net Realizable Value (same as accounting for accounts receivable). Long-Term ◦ FASB requires companies disclose not only their original value 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. Accounting 301A-Eiler 41 Example: Fair Value Option Facts: ◦ ◦ Fair Value of N/R $ 810,000 Carrying Value of N/R $ 620,000 After Election to use Fair Value Option, Company must record an adjusting entry: A L C NI Debit Credit Notes Receivable Unrealized Holding Gain Accounting 301A-Eiler 190,000 190,000 42 Other Receivables Issues Disposition ◦ ◦ Secured Borrowing Sales of Receivables – with or without recourse. Accounting 301A-Eiler 43 Dispositions Companies can transfer A/R or N/R for cash if (1) need to generate cash quickly or (2) it’s too costly to handle billing and collection inhouse or (3) to minimize credit exposure. 1. Secured Borrowing “Assign” or “Pledge” Receivables Holder retains ownership. 2. Sales of Receivables “Factor” or “Securitize” Receivables Holder transfers ownership. Accounting 301A-Eiler 44 Accounting 301A-Eiler 45 Secured Borrowing Seller is borrowing money from transferee. Receivables act as collateral. ◦ If Seller (Transferor) doesn’t repay loan, Creditor can get the cash by collecting the receivables. Accounting (Transferor): Business as usual for recording A/R collections, write-offs, etc. ◦ Receivables stay on the books of the company borrowing money (and a liability is recorded). ◦ Disclose arrangement in Notes to Financial Statements. ◦ Generally records an up-front finance charge (in Accounting 301A-Eiler ◦ 46 Secured Borrowing Journal Entry to Record Transaction: Cash Finance Charge Note Payable Journal XXX XXX XXX Entry to Record Remittances: Interest Expense Notes Payable (=cash collected from customers Cash Accounting 301A-Eiler XXX XXX XXX 47 Sales of Receivables Option ◦ 1: Factor Company or Bank (i.e., Factor) buys the receivables. Option 2: Securitize Transferor (i.e., Company) creates a Special Purpose Entity (SPE). ◦ SPE buys pools (bundles) or receivables from transferor. ◦ SPE sells related securities (e.g., bonds or commercial paper) that are backed by the Accounting 301A-Eiler (the receivables serve as 48 receivables ◦ Sale Without Recourse Buyer has no recourse to the seller if customers don’t pay. ◦ ◦ Factor assumes all risk of uncollectibility. Record transaction as a sale of an asset. Receivables removed from transferor’s books, cash is received and a loss on sale is recognized. Transferor records estimated amounts to be retained by the Factor for probable discounts, returns & allowances in a receivable called “Due from Factor”. (Factor records a liability account “Due to Factor”). Accounting 301A-Eiler 49 Sale With Recourse Transferor (seller) keeps risk of uncollectibility. ◦ Seller guarantees buyer will get paid even if some customers don’t pay. As long as three conditions for sale treatment are met, still account for transfer as a sale. ◦ If not, account for as secured borrowing. Accounting: 1. Transferors records applicable amounts 50 “Due from Factor” as in sale with recourse. Accounting 301A-Eiler Sale With Recourse 1. Calculate Net Proceeds = Cash Received + Due from Factor - Recourse Obligation 2. Calculate Loss on Sale of Receivables = Carrying (book) Value of Receivables - Net Proceeds Accounting 301A-Eiler 51 Sale With Recourse Journal Entries Seller (Transferor) Dr. Factor (Transferee) Cr. Dr. Cash XXX Due from Factor XXX Due to Seller XXX Loss on Sale of Rcvbls A/R or N/R XXX Financing Revenue Cash XXX Recourse Liability Accounting 301A-Eiler A/R Cr. XXX XXX XXX XXX 52 Practice Problems Dispositions Accounting 301A-Eiler of Receivables 53 Chapter 7: Key Concepts Know the components of Cash & Cash Equivalents. Know how to report Trade Discounts using Gross & Net methods. Understand how the Direct Write-off and Allowance Methods work. Know how to interpret and record various Notes Receivable Transactions. Understand the accounting for Accounting 301A-Eiler of receivables. 54 dispositions ...
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This note was uploaded on 11/08/2011 for the course ECON 102 taught by Professor Smith during the Spring '11 term at Saddleback.

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