Chapter 7

Report
Chapter 7
Cash and Receivables
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1. Cash

Few problems
◦ easy valuation and classification
◦ requires significant controls (Appendix 7A)


Petty cash (Appendix 7A)
Bank reconciliations (Appendix 7A)
◦ BE 7-15

Restrictions on cash
◦ disclosure
◦ presentation
◦ compensating balances

Cash equivalents
◦ highly liquid investments
◦ 3 months or less maturity
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1. Cash
Illustration 7-2
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2. Accounts and Notes Receivable

Receivables
◦ claims held against customers and others for
money, goods, or services


A/R – oral promises to pay
N/R – written promises to pay
◦ a negotiable instrument

Trade vs. Nontrade receivables
◦ trade – customers
◦ nontrade – officers, stockholders, affiliates,
deposits
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3. A/R – Bad Debts

Bad debts
◦ uncollectible accounts receivable

Two methods of accounting
◦ direct write-off method (not GAAP)
 does not apply matching
◦ allowance method (GAAP)
 correctly applies matching
 reflects proper YE carrying value of A/R
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3. A/R – Bad Debts

Direct write-off method
◦ expense recorded when account deemed
uncollectible
◦ easy to apply
◦ entry
Bad Debts Expense
Accounts Receivable
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X
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3. A/R – Bad Debts

Allowance method
◦ requires YE adjusting entry
◦ can be based on
 percentage of sales
 or percentage of receivables
◦ accounts in the entries are same with either
method
 the methods only affect the amounts for the entries
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3. A/R – Bad Debts

Allowance method
◦ YE adjusting entry
Bad Debts Expense
X
Allowance for Uncollectibles
X
◦ entry to write off specific A/R
Allowance for Uncollectibles
X
Accounts Receivable
X
 entry does not create an expense
 entry does not change net receivables
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3. A/R – Bad Debts

Examples
◦ BE 7-4
◦ BE 7-5

Collection of previously written-off A/R
◦ reinstate account balance
◦ record collection as normal
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4. Other Valuation Allowances

Discounts
◦ YE adjustment needed to estimate amount of
outstanding transactions with possible
discounts or returns
◦ e.g., entry for estimated returns
Sales Returns and Allowances
Allowance for Returned Merchandise
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X
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4. Other Valuation Allowances

Discounts
◦ trade
 reduction off list price used to determine sales price
 not recognized in books
◦ cash
 discount for prompt payment
 e.g., 2/10, n/30
 can be accounted for by gross or net methods
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4. Other Valuation Allowances

Example – cash disc net and gross methods
Make all entries under: (a) gross method
(b) net method
Date
Oct. 1
Sell $1,000 of merchandise to customer, 2/10, n/30
Oct. 7
Customer returns $100 of merchandise
Oct. 10
Customer pays in full
Assume Oct. 10 payment did not occur
Oct. 27
Customer pays in full
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5. Pledging, Assigning, & Factoring A/R

Reasons
◦ obtain cash now rather than wait for collection
◦ obtain relief from burden of carrying receivables

Can be accomplished by
◦ secured borrowing
 pledge receivables as collateral for a loan
◦ sale of receivables
 with recourse (seller still has risks of collection)
 without recourse (purchaser assumes risks)
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5. Pledging, Assigning, & Factoring A/R


Secured borrowing on receivables
A borrowing type arrangement
◦ can be general receivables pledged as collateral for
loan (all receivables or certain dollar amount)
◦ can be specific receivables pledged as collateral for
loan (then must identify receivables pledged)


Company continues to collect A/R
Bank usually
◦ charges a finance charge against receivables
◦ charges interest on the loan
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5. Pledging, Assigning, & Factoring A/R

Example – Secured Borrowing
◦ You pledge all your receivables as collateral for
a bank loan. The balance of A/R is $75,000 and
bank loan amount is $50,000. The bank
charges a 1% fee on the receivables and
interest on the loan is 10%.
Record the entries for this transaction.
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5. Pledging, Assigning, & Factoring A/R
Date
1/1/year 1
Accounts
Cash
Dr.
Cr.
49,250
Interest Expense (75,000 x .01)
750
Notes Payable
50,000
You collect $45,000 of A/R on 3/31/year 1
3/31/year 1
Cash
45,000
A/R
45,00
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5. Pledging, Assigning, & Factoring A/R
Date
Accounts
Dr.
Cr.
You remit collections to bank plus interest on loan.
3/31/year 1
Interest Expense (50,000 x .1 x 1/4)
Notes Payable
1,250
45,000
Cash
46,250
You collect remainder of A/R on 6/30/year 1
6/30/year 1
Cash
30,000
A/R
30,000
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5. Pledging, Assigning, & Factoring A/R
Date
Accounts
Dr.
Cr.
You pay remainder of loan to bank plus interest on loan.
6/30/year 1
Interest Expense (5,000 x .1 x 1/4)
Notes Payable
125
5,000
Cash
5,125
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5. Pledging, Assigning, & Factoring A/R

Selling (factoring) receivables
◦
◦
◦
◦

usually for all receivables
usually continuous arrangement
fee usually 1% - 3%
usually a holdback (for returns and allowances)
Factoring without recourse
◦ a sale and record loss

Factoring with recourse
◦ a sale, but follows financial components approach
◦ must assign a liability to the recourse provision to
compute the loss
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5. Pledging, Assigning, & Factoring A/R

Example
◦ A company factors its A/R balance of $40,000
with a factoring fee of 2% and a 10% holdback.
Record the entries if the transaction is
(a) without recourse
(b) with recourse
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5. Pledging, Assigning, & Factoring A/R
(a) without recourse
Accounts
Dr.
Cash
Cr.
35,200
Receivable from Factor (40,000 x .1)
4,000
Loss on Sale of A/R (40,000 x .02)
800
A/R
40,000
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5. Pledging, Assigning, & Factoring A/R
(b) with recourse; assume the recourse
obligation has a fair valued of $2,000
Compute net proceeds:
Cash received
$35,200
Add: Holdback
4,000
Less: Recourse obligation
Net Proceeds
$39,200
2,000
$37,200
Compute Loss on Sale:
BV of A/R
Net Proceeds
Loss on Sale
$40,000
37,200
$ 2,800
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5. Pledging, Assigning, & Factoring A/R
(b) With recourse
Accounts
Dr.
Cash
Cr.
35,200
Due From Factor
4,000
Loss on Sale of A/R
2,800
A/R
40,000
Recourse Liability
2,000
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6. Notes Receivable

Recognition of N/R
◦ short-term N/R
 recorded at face value
◦ long-term N/R
 recorded at PV of future cash flows

Notes can be received for
◦ loaning money
◦ selling goods or services

Notes can have a stated interest rate or no interest rate
◦ Stated interest rate on N/R can be
 equal to market rate, greater than market rate, or less than market rate
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6. Notes Receivable
Interest-bearing notes
Example
You received a $1,000, two year, 6% note
receivable in exchange for merchandise.

Make entries to record this transactions if the
market interest rate is:
(a) 6%
(b) 8%
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6. Notes Receivable
(a) market interest rate is 6%
PV of 2 year, 6%, $1,000 note discounted at 6% = 1,000
(n=2, i=6, PMT=60, FV=1000, CPT PVA-ord)
PV of interest payments
PVA-ord(2, 6%) = 60 x 1.83339 = 110
PV of principle payment
PV = 1,000 x .89000
= 890
1,000
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6. Notes Receivable
(a) market interest rate is 6%
Date
1/1/year 1
Accounts
Notes Receivable
Dr.
1,000
Sales
12/31/year 1
1,000
Cash
60
Interest Revenue
12/31/year2
60
Cash
60
Interest Revenue
12/31/year2
Cr.
60
Cash
1,000
Notes Receivable
1,000
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6. Notes Receivable
(b)
market interest rate is 8%
PV of 2 year, 6%, $1,000 note discounted at 8% = 964
(n=2, i=8, PMT=60, FV=1000, CPT PVA-ord)
PV of interest payments
PVA-ord(2, 8%) = 60 x 1.78326 = 107
PV of principle payment
PV = 1,000 x .85734
= 857
964
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6. Notes Receivable
Date
1/1/year 1
Accounts
Notes Receivable
Dr.
1,000
Discount on N/R
36
Sales
12/31/year 1
964
Cash
60
Discount on N/R
17
Interest Revenue (964 x .08)
12/31/year 2
77
Cash
60
Discount on N/R
19
Interest Revenue (964 + 17 = 981; 981 x .08 = 79)
12/31/year 2
Cr.
Cash
79
1,000
Notes Receivable
1,000
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6. Notes Receivable

Non-interest-bearing note
◦
◦
◦
◦
zero percent interest is unreasonable
must impute interest rate
use imputed rate to amortize note
Also
 interest rate in arm’s length transaction is
considered reasonable unless
 zero interest rate
 clearly unreasonable interest rate
 face amount of note significantly differs from cash sales price
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6. Notes Receivable
Example
You accept a $12,500, three year, noninterest-bearing note for the sale of
merchandise. The merchandise has a cash
price of $10,000.
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6. Notes Receivable
Example
N =3
i =?
PV = $10,000
FV = $12,500

i
= 7.7%
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Date
Accounts
6. Notes
Receivable
Notes Receivable
1/1/year 1
Dr.
12,500
Discount on N/R
2,500
Sales
12/31/year 1
10,000
Discount on N/R
770
Interest Revenue (12500-2500=10000;
10000 x .077 = 770)
12/31/year 2
Discount on N/R
770
829
Interest Revenue (2500 – 770 = 1730;
12500-1730 =10770; 10770 x .077 = 829)
12/31/year 3
Discount on N/R
829
901*
Interest Revenue (1730 – 829 = 901;
901*
12500-901=11599; 11599x .077 ≈ 901)
12/31/year 3
Cr.
Cash
*=
rounded
12,500
Notes Receivable
12,500
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7. Fair Value Option
FASB allows financial instruments to be
valued at fair value
 If company chooses fair value option

◦ adjust notes to FV at year-end
◦ unrealized holding gains or losses included in
net income

Once elected must always continue to be
used
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