On Dec. 31, 2014, MusicLand has $50000 in accounts receivable

Report
Cash and Receivables
Chapter 7
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
7-2
Cash and Cash Equivalents
Cash
Currency
and coins
Balances in
checking
accounts
Items for deposit such as
checks and money orders
from customers
Cash equivalents are short-term, highly liquid
investments that can be readily converted to cash.
Money market
funds
Treasury bills
Commercial
paper
7-3
Internal Control
Encourages adherence to
company policies
and procedures
Promotes operational
efficiency
Minimizes errors
and theft
Enhances the reliability and
accuracy of accounting data
7-4
Internal Control Procedures
Cash Receipts
 Separate responsibilities for receiving cash, recording cash
transactions, and reconciling cash balances.
 Match the amount of cash received with the amount of cash
deposited.
 Close supervision of cash-handling and cash-recording
activities.
Cash Disbursements

All disbursements, except petty cash, made by check.

Separate responsibilities for cash disbursement documents,
check authorization, check signing, and record keeping.

Checks should be signed only by authorized individuals.
Restricted Cash and
Compensating Balances
Restricted Cash
Management’s intent to use a certain amount
of cash for a specific purpose – future plant
expansion, future payment of debt.
Compensating Balance
Minimum balance that must be
maintained in a company’s bank
account as support for funds
borrowed from the bank.
7-5
7-6
U.S. GAAP vs. IFRS
In general, cash and cash equivalents are
treated similarly under IFRS and U.S. GAAP. One difference
is highlighted below.

Bank overdrafts are treated
as liabilities.

Bank overdrafts may be
offset against other cash
accounts.
7-7
Accounts Receivable
Result from the credit
sales of goods or
services to customers.
Are classified as
current assets.
Are recorded net of
trade discounts.
7-8
Cash Discounts
increase sales
Cash discounts
encourage early
payment
increase likelihood of
collections
7-9
Cash Discounts
2/10,n/30
Discount
percent
Number of
days
discount is
available
Otherwise,
net (or all)
is due
Credit
period
7-10
Cash Discounts
Gross
Method
Net
Method
Sales are recorded
at the invoice
amounts.
Sales are recorded at
the invoice amount
less the discount.
Sales discounts
are recorded as reduction
of revenue if payment is
received within the
discount period.
Sales discounts forfeited
are recorded
as interest revenue if
payment is received after
the discount period.
7-11
Cash Discounts
On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10,
n/30. On October 14, the customer sent a check for $13,720 taking
advantage of the discount to settle $14,000 of the amount. On November
4, the customer paid the remaining $6,000.
October 5, 2013
October 5, 2013
October 14, 2013
October 14, 2013
November 4, 2013
November 4, 2013
7-12
Sales Returns
Merchandise
may be
returned by a
customer to
a supplier.
A special price
reduction, called
an allowance,
may be given as
an incentive to
keep the
merchandise.
To avoid misstating the financial statements,
sales revenue and accounts receivable should
be reduced by the amount of returns in the
period of sale if the amount of returns is
anticipated to be material.
7-13
Sales Returns
During the first year of operations, Hawthorne sold $2,000,000 of
merchandise that had cost them $1,200,000 (60%). Industry
experience indicates a10% return rate. During the year $130,000 was
returned prior to customer payment. Record the returns and the end
of the year adjustment.
Actual Returns
Sales returns
Accounts receivable
Inventory
Cost of goods sold (60%)
Adjusting Entries
Sales returns
Allowance for sales returns
Inventoryestimated returns
Cost of goods sold (60%)
130,000
130,000
78,000
78,000
70,000
70,000
42,000
42,000
7-14
Uncollectible Accounts Receivable
Bad debts result from credit customers who are
unable to pay the amount they owe, regardless of
continuing collection efforts.
In conformity with the matching
principle, bad debt expense should
be recorded in the same accounting
period in which the sales related to
the uncollectible account were
recorded.
PAST DUE
7-15
Uncollectible Accounts Receivable
Most businesses record an estimate of the bad
debt expense by an adjusting entry at the
end of the accounting period.
Normally classified as
a selling expense and
closed at year-end.
Contra asset account to
accounts receivable.
Bad debt expense
Allowance for uncollectible accounts
xxx
xxx
7-16
Allowance for Uncollectible Accounts
Accounts Receivable
Less: Allowance for Uncollectible Accounts
Net Realizable Value
Net realizable value is the amount of the accounts
receivable that the business expects to collect.


Income Statement Approach
Balance Sheet Approach


Composite Rate
Aging of Receivables
7-17
Income Statement Approach

Focuses on past credit sales to make estimate
of bad debt expense.

Emphasizes the matching principle by
estimating the bad debt expense associated
with the current period’s credit sales.
Bad debt expense is computed as follows:
Current Period Credit Sales
× Estimated Bad Debt %
= Estimated Bad Debt Expense
7-18
Income Statement Approach
In 2014, MusicLand has credit sales of $400,000 and
estimates that 0.6% of credit sales are uncollectible.
What is Bad Debt Expense for 2014?
MusicLand computes
estimated Bad Debt
Expense of $2,400.
$
×
= $
400,000
0.60%
2,400
Bad debt expense
Allowance for uncollectible accounts
2,400
2,400
7-19
Balance Sheet Approach


Focuses on the collectability of accounts receivable to
make the estimate of uncollectible accounts.
Involves the direct computation of the desired balance in
the allowance for uncollectible accounts.
Compute the desired balance in the allowance for
uncollectible accounts.
Bad debt expense is computed as:
Desired Balance in Allowance for
Uncollectible Accounts
Existing Year-End Balance in Allowance for
Uncollectible Accounts
= Estimated Bad Debt Expense
-
Balance Sheet Approach
Composite Rate
On Dec. 31, 2014, MusicLand has
$50,000 in accounts receivable
and a $200 credit balance in
allowance for uncollectible
accounts.
Past experience suggests that 5%
of receivables are uncollectible.
What is MusicLand’s bad debt
expense for 2014?
7-20
7-21
Balance Sheet Approach
Composite Rate
Determine the desired
balance in allowance
for uncollectible accounts
$
×
= $
50,000
5.00%
2,500
Allowance for
Uncollectible
Accounts
200
Bad debt expense
Allowance for uncollectible accounts
2,300
2,500
2,300
2,300
Balance Sheet Approach
Aging of Receivables
 Year-end accounts receivable is broken
down into age classifications.
 Each age grouping has a different
likelihood of being uncollectible.
 Compute required uncollectible
amount.
 Compare required uncollectible
amount with the existing balance in the
allowance account.
7-22
7-23
Balance Sheet Approach
Aging of Receivables
At December 31, 2014, the receivables for
EastCo, Inc., were categorized as follows:
EastCo, Inc.
Schedule of Accounts Receivable by Age
Days Past Due
Current
1  30
31  60
Over 60

December 31, 2014
Accounts
Estimated
Receivable
Percent
Balance
Uncollectible
$
$
45,000
15,000
5,000
2,000
67,000

Estimated
Allowance
1% $
3%
5%
10%
$
450
450
250
200
1,350

7-24
Balance Sheet Approach
Aging of Receivables

EastCo’s unadjusted balance in
the allowance account is $500.

Per the previous computation,
the required balance is $1,350.
Allowance for
Uncollectible
Accounts
500
Bad debt expense
Allowance for uncollectible accounts
850
1,350
850
850
7-25
Uncollectible Accounts
As accounts are deemed to be uncollectible, a journal
entry is made to record the actual write-off.
Allowance for uncollectible accounts
Accounts receivable
500
500
If a customer makes a payment after an account has
been written off, two journal entries are required.
Accounts receivable
Allowance for uncollectible accounts
500
Cash
500
Accounts receivable
500
500
7-26
Direct Write-off Method
If uncollectible accounts are immaterial, bad debts
are simply recorded as they occur (without the
use of an allowance account).
Bad debts expense
Accounts receivable
xxx
xxx
Summary of Measurement and Reporting
Issues for Accounts Receivable
Recognition
Depends on the earnings process; for most credit sales,
revenue and the related receivables are recognized at the
point of delivery.
Initial valuation
Initially recorded at the exchange price agreed upon by the
buyer and seller.
Subsequent valuation
Initial valuation reduced to net realizable value by:
1. Allowance for sales returns
2. Allowance for uncollectible accounts:
The income statement approach
 The balance sheet approach
Classification
Almost always classified as a current asset.
7-27
7-28
Notes Receivable
A written promise to pay a specific
amount at a specific future date.
Face
amount
of the
note
×
Annual
interest
rate
Even for
maturities less
than 1 year, the
rate is
annualized.
×
Fraction of
the annual =
period
Interest
7-29
Interest-Bearing Notes
On November 1, 2014, West, Inc., loans $25,000 to Winn Co. The
note bears interest at 12% and is due on November 1, 2015.
Prepare the journal entry on November 1, 2014, December 31,
2014, (year-end) and November 1, 2015, for West.
November 1, 2014
Notes receivable
Cash
December 31, 2014
Interest receivable
Interest revenue
November 1, 2015
Cash
Note receivable
Interest receivable
Interest revenue
25,000
25,000
500
500
28,000
25,000
500
2,500
7-30
Noninterest-Bearing Notes

Actually do bear interest.

Interest is deducted
(discounted) from the face
value of the note.

Cash proceeds equal face
value of note less discount.
7-31
Noninterest-Bearing Notes
On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterestbearing note from Winn Co. as payment for a sale. The note is
discounted at 12% and is due on Dec. 31, 2014.
Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014.
January 1, 2014
Notes receivable
Discount on notes receivable
Sales revenue
($25,000 * 12% = $3,000)
December 31, 2014
Cash
Discount on notes receivable
Interest revenue
Note receivable
25,000
3,000
22,000
25,000
3,000
3,000
25,000
7-32
U.S. GAAP vs. IFRS
In general, IFRS and U.S. GAAP are very similar with respect
to accounts receivable and notes receivable. Differences are
highlighted below.

U.S. GAAP allows a “fair value
option” for accounting for
receivables.

U.S. GAAP does not allow
receivables to be accounted for as
“available for sale” investments.

U.S. GAAP requires more
disaggregation of accounts and
notes receivable in the balance
sheet or notes.

IFRS restricts the circumstances in
which a “fair value option” for
accounting for receivables is
allowed.

Until 2015, companies may account
for receivables as “available for sale”
investments if the approach is
elected initially. After January 1,
2015, this treatment is no longer
allowed.
7-33
Financing with Receivables
Companies may use their
receivables to obtain
immediate cash.
7-34
Factoring Arrangements
2. Accounts Receivable
SUPPLIER
(Transferor)
RETAILER
1. Merchandise
FACTOR
(Transferee)
A factor is a financial institution that buys receivables
for cash, handles the billing and collection of the
receivables, and charges a fee for the service.
7-35
Secured Borrowing
On December 1, 2013, the Santa Teresa Glass Company borrowed $500,000 from Finance
Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned
$620,000 of its receivables as collateral for the loan. Finance Bank charges a finance fee equal
to 1.5% of the accounts receivable assigned.
Cash (difference)
Finance charge expense (1.5% * $620,000)
Liability – financing arrangement
490,700
9,300
500,000
Santa Teresa Glass will continue to collect the receivables, and will record any discounts, sales
returns, and bad debt write-offs, but will remit the cash to Finance Bank, usually on a monthly
basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa
Glass records the following entries.
Cash
400,000
Accounts receivable
400,000
Interest expense ($500,000 * 12% * 1/12)
Liability – financing arrangement
Cash
5,000
400,000
405,000
7-36
Sale of Receivables
Treat as a sale if all of these conditions are met:
 receivables are isolated from transferor.
 transferee has right to pledge or exchange receivables.
 transferor does not have control over the receivables.


Transferor cannot repurchase
receivable before maturity.
Transferor cannot require return
of specific receivables.
7-37
Sale of Receivables
Without recourse




An ordinary sale of receivables to the factor.
Factor assumes all risk of uncollectibility.
Control of receivable passes to the factor.
Receivables are removed from the books, fair value of cash and
other assets received is recorded, and a financing expense or
loss is recognized.
With recourse


Transferor (seller) retains risk of uncollectibility.
If the transaction fails to meet the three conditions
necessary to be classified as a sale, it will be treated as
a secured borrowing.
7-38
Sale of Receivables
In December 2013, the Santa Teresa Glass Company factored accounts receivable that
had a book value of $600,000 to Factor Bank. The transfer was made without recourse.
Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor,
and Factor immediately remits to Santa Teresa cash equal to 90% of the factored
amount (90% × $600,000 = $540,000). Factor retains the remaining 10% (estimated to
have a fair value of $50,000) to cover its factoring fee (equal to 4% of the total factored
amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales
returns and allowances.
Assume the same facts as above, except that Santa Teresa Glass sold the receivables
to Factor with recourse and estimates the fair value of the recourse obligation to be
$5,000.
7-39
Sale of Receivables
Securitization: Transfer receivables to a SPE
Special Purpose Entity (SPE)
Qualifying Special Purpose Entity (QSPE)
New rules eliminate QSPE and require consolidation!
Participating Interests: Transfer portion of a receivable
Example: transfer right to interest, but retain right to
principal
New rules require a partial transfer be treated as a
secured borrowing, unless specific conditions are
met!
7-40
Transfers of Notes Receivable
On December 31, Stridewell accepted a nine-month 10 percent
note for $200,000 from a customer. Three months later on
March 31, Stridewell discounted the note at its local bank. The
bank’s discount rate is 12 percent.
Before preparing the journal entry to record the
discounting, Stridewell must record the accrued interest on
the note from December 31 until March 31.
Interest receivable
Interest revenue
$200,000 × 10% × 3/12
5,000
5,000
7-41
Transfers of Notes Receivable
Face amount of note receivable
Interest to maturity ($200,000 × 10% × 9/12)
Maturity value of note receivable
Discount fee ($215,000 × 12% × 6/12)
Cash proceeds
Cash
Loss on sale of note receivable
Notes receivable
Interest receivable
$
$
200,000
15,000
215,000
(12,900)
202,100
202,100
2,900
$205,000  $202,100
200,000
5,000
Deciding Whether to Account for a Transfer
as a Sale or a Secured Borrowing
7-42
7-43
U.S. GAAP vs. IFRS
The U.S. GAAP and the IFRS approaches often
lead to similar accounting treatment for transfers
of receivables.

U.S. GAAP focuses on whether
control of assets has shifted from
the transferor to the transferee.

IFRS requires a more complex
decision process. The company has
to have transferred the rights to
receive the cash flows from the
receivable, and then considers
whether the company has
transferred “substantially all of the
risks and rewards of ownership,” as
well as whether the company has
transferred control.
7-44
Receivables Management
Receivables
Turnover =
Ratio
Net Sales
Average Accounts Receivable
This ratio measures how many
times a company converts its
receivables into cash each year.
Average
Collection
Period
365
=
Receivables Turnover Ratio
This ratio is an approximation of the
number of days the average accounts
receivable balance is outstanding.
7-45
Receivables Management
Symantec Corp. vs. CA, Inc., comparison
(All dollar amounts in millions)
Accounts receivable (net)
Net sales
Receivables turnover
Average collection period
Symantec Corp.
CA, Inc.
2011
2010
2011
2010
$
1,013 $
856 $
849 $
931
6,190
4,429
Symantec Corp
6.62
55.14 days
CA, Inc
4.98
73.29 days
Industry Average
5.96
61.3 days
7-46
Appendix 7-A: Cash Controls
A bank reconciliation explains the difference between cash reported
on bank statement and cash balance on a company’s books.
Provides information for reconciling journal entries.
Bank Balance
Book Balance
+ Deposits in Transit
+ Bank Collections
- Outstanding Checks
- Service Charges
- NSF Checks
± Bank Errors
= Corrected Balance
± Book Errors
= Corrected Balance
7-47
Appendix 7-A: Cash Controls
Petty cash is
used for
minor
expenditures.
Petty cash
fund
Has one
custodian.
Replenished
periodically.
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
When a company holds a receivable from
another company, there is some potential that
the receivable will eventually be impaired.
Impairment of a receivable
occurs if the company believes
it is probable that it will not
receive all of the cash flows
(principal and any interest
payments) associated with the
receivable.
7-48
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
Bad debt expense
Accrued interest receivable
Allowance for uncollectible accounts
($30,000,000 - $24,132,330)
8,867,670
3,000,000
5,867,670
7-49
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
7-50
A troubled debt restructuring occurs when a
creditor makes concessions in response to a debtor’s
financial difficulties.
Sometimes a receivable in a troubled debt restructuring is actually settled at
the time of the restructuring by the debtor making a payment of cash, some
other noncash assets, or even shares of the debtor’s stock.
Land (fair value)
Bad debt expense
Accrued interest receivable
Notes receivable
(in millions)
20
13
3
30
7-51
U.S. GAAP vs. IFRS
The U.S. GAAP and the IFRS approaches to impairments
of receivables are similar, but the process and criteria are
somewhat different.

Under U.S. GAAP the level of analysis is
individual receivables.

U.S. GAAP provides an illustrative list of
information to consider when evaluating
receivables for impairment, and requires
measurement of potential impairment if
impairment (a) is viewed as probable and
(b) can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of
impairments the same.

Under IFRS the level of analysis starts with
consideration of impairment for
individually significant receivables.

IFRS provides an illustrative list of “loss
events” and requires measurement of an
impairment if there is objective evidence
that a loss event has occurred that has an
impact on the future cash flows collected
and that can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of
impairments the same.
7-52
End of Chapter 7

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