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					    Chapter 7

Cash and Receivables
 Walk Through Balance Sheet

 Chapter 1 – 5
   Accounting cycle: JE, AJE, financial stmts
   Conceptual framework, GAAP, revenue
 Remaining chapters (ACTG 161, 162)
     Start at top of balance sheet (Cash)
     Finish at bottom (Stockholders’ equity)
     Look at each balance sheet account
     Related income statement accounts
           Learning Objectives
   Identify items considered cash
   Indicate how to report cash and related items
   Define receivables, identify types of receivables
   Recognition of accounts receivable
   Valuation of accounts receivable
   Recognition of notes receivable
   Valuation of notes receivable
   Disposition of accounts and notes receivable
   Reporting and analyzing receivables
        Learning Objectives

 Identify items considered cash
 Indicate how to report cash
  Dr. Pepper, AMR, Blockbuster, SAP, Peet’s,
        Whole Foods (restricted cash)
A/R:Apple,Dominos, Office Depot (n), Tiffany (n)
                   Cash

 Accepted deposit at financial institutions
     Coins and currency
     Checks from customers and money orders
     Certified checks and cashier’s checks
     Savings accounts
     Petty cash
 Amounts ready to deposit counted as
  cash, even though not deposited
            Cash Equivalents

 Earn interest on unneeded cash
 Readily convertible to cash
     Highly liquid debt securities
     Maturities of 90 days or less
     Highest rating, AAA; little interest rate risk
     Similar to money market fund
           Interest = Principal × Rate × Time
      Interest = $10,000,000,000 × 3% × 30/360
                  Interest = $25,000,000
         Cash Equivalents

 Maturity dates of three months or less
  when purchased
   Commercial paper
   Treasury bills
   Money market funds
  Cash and Cash Equivalents

 Readily available to
   Pay off debt
   Use in operations
 No legal or contractual restrictions
 No distinction between
   Cash
   Cash equivalents
 Restricted cash NOT cash or equivalent
          Restricted Cash

 Only cash available for current
  operations or to pay current liabilities
  should be classified as “cash or equiv”
 Restrictions on cash can be
   Informal, arising from management intent
   Contractually imposed
          Restricted Cash

 Cash that is restricted and not available
  for current use usually is reported as
   Investments
   Other assets
 Can be current or non-current asset
 Disclosure required
               Informal

 Management’s intent to use a certain
  amount of cash for a specific purpose
   Plant expansion
   Payment of debt
 Cannot be classified as Cash
               Not Cash

 If not readily convertible to cash with no
  penalties or restrictions, not cash
 Must look at nature of asset
 Example: Certificate of deposit (CD)
 Classify as Short-term investment
     Compensating Balance

 Restricts use of cash borrowed
 Minimum balance required in bank
  account to reduce risk to bank
 Can be current of noncurrent
 Disclosure required
 If contractual requirement not cash
 If informal may be cash
       Compensating Balance
Amount borrowed                          $10,000,000
Compensating balance                       2,000,000
Available for use                         $8,000,000
Interest rate                                   12%
Interest per year              10,000,000 × 12% =
                                            1,200,000
Effective interest rate 1,200,000 / 8,000,000 = 15%
Compensating balance increases effective interest rate
           Bank Overdrafts

 When a company writes aas a current liability
  Generally reported check for more than the
  amount in its cash account.
 Offset against cash account only when
  available cash is present in another
  account at same bank
Codification: 305 Cash and Cash
       Learning Objectives

 Define receivables, identify types of
  receivables
 Recognition of accounts receivable
 Valuation of accounts receivable
             Receivables

 Claims held against customers and
  others for money, goods, or services
   Accounts receivable
   Notes receivable
        Accounts Receivable

   We are seller
   Goods are delivered, service provided
   Promise of purchaser to pay
   Open account
   Short-term extension of credit
   Usually 30 to 60 days
   No interest if paid on time
           Notes receivable

 We are lender
 Use note receivable when
   Larger amount
   Repayment longer term
 Contract signed by borrower stating
   Principal
   Interest (stated interest rate)
   Due date
      Non-trade Receivables
Nontrade Receivables

 Advances or loans to employees
 Advances or loans to subsidiaries
 Deposits for potential damages / losses
 Deposits as a guarantee of performance
  or payment
 Dividends and interest receivable
          Accounts Receivable

   Trade receivables: Receivables from
    sale of goods or services on account
   Deliver merchandise or service today,
    customer pays later
   Current asset: Converted to cash within
    normal operating cycle
Date   Description              Debit    Credit
       Accounts receivable      5,000
         Sales                           5,000
        Accounts Receivable

   Record receivable at amount of sale
   Do not use present value
   Difference between PV and FV small
   APB Opinion 21 excludes accounts
    receivable from PV valuation
          Accounts Receivable

   Maintain accounts receivable in total
   Maintain account receivable ledger for
    each customer

Date   Description                   Debit   Credit
       Accounts receivable / Aston   5,000
          Sales                              5,000
GENERAL       ACCOUNTS RECEIVABLE
LEDGER         SUBSIDIARY LEDGERS

 Accounts
 Receivable           Aston
5,000             5,000
1,000
3,000
                      Harris
                  1,000


                     Salazar
                  3,000
                Trade Discounts

    Seller publishes price list
    Buyers given discount off list price
    Trade discount reduces selling price
    Record sale net of discount
    List price – trade discount = sell price
    No entry made for discount amount
       If more than one trade discount, apply in chain;
    second discount applied to net amount after first disc.
                    Trade Discount
  Description                  Item Number                       Price
  Bookcase                     NCK749                        $1,200
  Chair                        JRK483                        $1,000
  Table                        TLW497                            $800

             Seller offers trade discount of 20%

Date      Description                             Debit           Credit
          Account receivable                       800
            Sales                                                   800
Sold one chair, 20% trade discount: $1,000 × (1 – 0.20) = $800
                    Trade Discount
  Description                    Item Number                  Price
  Bookcase                       NCK749                      1,200
  Chair                          JRK483                      1,000
  Table                          TLW497                        800

       Seller offers trade discounts of 20%, 15%, 10%

Date      Description                            Debit         Credit
          Account receivable                      612
            Sales                                                612
Sold one chair with trade discounts: $1,000 × 0.80 × 0.85 × 0.90 =
$612
  Cash Discounts (Sales Disc.)




 2/10,n/30
Discount   Number of     Otherwise,     Credit
Percent       Days       Net (or All)   Period
           Discount is     is Due
            Available
           Cash Discounts

 Reduces amount buyer pays if payment
  made within a specified period of time
   Increase sales
   Encourage early payment
   Increase likelihood of collections
Cash Discounts: Gross Method

 Sales are recorded at invoice amounts
 Sales discounts recorded if payment
  received within discount period
 Discount not taken is sales revenue
 Cash Discounts: Net Method

 Sales recorded at invoice less discount
 Sales discounts forfeited if payment
  received after discount period
 Discount not taken is interest revenue
          Cash Discounts

 Net method preferred by GAAP
 Difference between the gross and net
  methods usually not material
 Most companies use gross method
     On May 10 sold $5,000 of merchandise,
          cash discount of 1/10, n/30.

                          Gross Method
Date     Description                     Debit   Credit
May 10   Accounts receivable             5,000
           Sales                                 5,000


                           Net Method
Date     Description                     Debit   Credit
May 10   Accounts receivable             4,950
           Sales                                 4,950
  On May 19 received payment in full payment
         for the sale made on May 10

                           Gross Method
Date     Description                      Debit   Credit
May 19   Cash                             4,950
         Sales discounts                    50
           Accounts receivable                    5,000


                            Net Method
Date     Description                      Debit   Credit
May 19   Cash                             4,950
           Accounts receivable                    4,950
   Financial Statements

   Income Statement (Gross method)
Sales                          $5,000
Sales discounts                    50
Net sales                       4,950

    Income Statement (Net method)
Sales                          $4,950
Other income:
Financing revenue                  0
         If payment in full received on May 31
              (not within discount period)

                          Gross Method
Date      Description                    Debit   Credit
May 31    Cash                           5,000
            Accounts receivable                  5,000


                           Net Method
Date      Description                    Debit   Credit
May 31    Cash                           5,000
            Accounts receivable                  4,950
            Financing revenue                       50
   Financial Statements

   Income Statement (Gross method)
Sales                          $5,000
Sales discounts                     0
Net sales                       5,000

    Income Statement (Net method)
Sales                          $4,950
Other income:
Financing revenue                 50
         Returns and Allowances

   Accounts receivable decreased
        Return: Merchandise returned
        Allowance: Buyer keeps merchandise

Date     Description                    Debit   Credit
         Sales returns and allowances   ?,???
           Accounts receivable                  ?,???
    Adjusting Journal Entries

 AJE required if returns or cash
  discounts in future periods are material
   Estimate future returns and discounts
   Record in same period as related sale
   Revenue realization principle
      ACCOUNT ACTIVITY

      Sales

              Sales




  Sales returns         Sales discounts

Returns               Discounts
              Net Sales

Sales (after trade discounts)
  Sales returns and allowances
  Sales discounts (cash discounts)

Net sales

    Revenue           Contra-revenue
      Accounts Receivable

 Will all receivable be collected? No!
 Balance sheet must show amount
  expected to be collected
 Net realizable value
 Bad debt expense is operating expense
 Match to revenue in period of sale
        Direct Write-off Method
Date   Description              Debit   Credit
       Bad debt expense         ?,???
         Accounts receivable            ?,???


   Not permitted by GAAP
   Only use direct write-off when
    uncollectible accounts immaterial
   Write-off account when identified
   No allowance account
     ALLOWANCE METHOD

 If uncollectible accounts material
   Allowance method required by GAAP
   Do not wait for specific accounts to
    become uncollectible
   Estimate future uncollectible accounts
   Match expense with related sales revenue
   Balance sheet shows net collectible
      Matching Principle

                    Sales
                   Revenue
Matching            Record in
Principle          same period

                   Bad Debt
                   Expense
     Accounts Receivable

Accounts receivable
 Allowance for uncollectible accounts

Net accounts receivable


     Asset                Contra-asset
ACCOUNT ACTIVITY

   Accounts receivable
                                Asset
     Sales      Returns
               Collections
               Write-offs


   Allow Uncollectible
                             Contra asset
  Write-offs    AJE Est.
       Estimate Bad Debt Expense

   Estimate bad debt expense with AJE

Date     Description                          Debit        Credit
         Bad debt expense                     ?,???
           Allowance for uncoll. acc.                          ?,???



       Assets          =      Liabilities +           Equity
                                                      
       Estimating Expense

 Two methods to estimate


   Percent
                             A/R
     of
                            Aging
    Sales
        Methods to Estimate
    Income
                     Balance Sheet
   Statement
                       Approach
   Approach
 Emphasis on         Emphasis on
  Matching          Realizable Value

Sales               Accts.
            Bad      Rec.      All. for
           Debts               Uncoll.
           Exp.                Accts.

                        Accounts
  Percentage of
                        receivable
      Sales
                          aging
       Percentage-of-Sales

 Estimate bad debt expense associated
  with credit sales in current period
 Income statement approach
   Match expense to revenue
   Income statement fairly stated
 Balance sheet (net A/R) not fairly stated
           Percent-of-sales

 Balances before year-end adjustments
                       Contra asset account


Accounts Receivable    Allow Uncollectible

 100,000                            5,000
                Percent-of-Sales

      Sales $500,000
      Uncollectible estimated 1.5% of sales
      Bad debt expense = $500,000 × 0.015
      Bad debt expense = $7,500

Date     Description                    Debit   Credit
         Bad debt expense               7,500
           Allowance for uncoll. acc.           7,500
           Percent-of-Sales


Accounts Receivable   Allow Uncollectible

 100,000                           5,000
                                   7,500
                                  12,500
           Percent-of-Sales

   Matched expense to revenue
   Income statement fairly stated
   Ignored values on balance sheet
   Balance sheet may not be fairly valued
   Errors from inaccurate estimates in
    previous periods never corrected
      Aging Of Receivables

 Age invoices, predict % not collected
 Estimate receivables not collectible
      Aging Of Receivables

 Balance sheet approach
 Balance sheet fairly stated
 Income stmt may not be fairly stated
  (no matching)
       Aging Of Receivables

 Balances before year-end adjustments

Accounts Receivable    Allow Uncollectible
 100,000                            5,000
           Days from invoice date
Invoice   1 – 30 31 – 60 61 – 90 90 +    Total
5367                              3,000   3,000
          Invoice number
5953                     15,000          15,000
6107              12,000                 12,000
                          Invoice amount
6153              13,000                 13,000
6244      30,000                         30,000
6287      27,000                         27,000
Total     57,000 25,000 15,000 3,000 100,000
Est %       2%     5%      10%    60%
Allow.     1,140 1,250    1,500 1,800     5,690
       Aging Of Receivables

 Aging estimates $5,690 not collectible

Accounts Receivable      Allow Uncollectible
                                      5,000
 100,000                               690
                                      5,690
         Aging Of Receivables

   Adjusting journal entry $690

  Accounts Receivable                 Allow Uncollectible
                                                     5,000
   100,000                                            690
                                                     5,690


Date   Description                           Debit       Credit
       Bad debt expense                       690
         Allowance for uncoll. acc.                          690
       Aging Of Receivables

 What if Allowance balance was $500?

Accounts Receivable    Allow Uncollectible
                                     500
 100,000                             ???
                                    5,690
         Aging Of Receivables

   Adjusting journal entry $5,190

  Accounts Receivable                 Allow Uncollectible
                                                     500
   100,000                                          5,190
                                                    5,690


Date   Description                          Debit       Credit
       Bad debt expense                     5,190
         Allowance for uncoll. acc.                     5,190
       Aging Of Receivables

 What if Allowance balance was $6,000?

Accounts Receivable    Allow Uncollectible
                                    6,000
 100,000                             ???
                                    5,690
          Aging Of Receivables

   Adjusting journal entry $310

  Accounts Receivable               Allow Uncollectible
                                                    6,000
   100,000                            310
                                                    5,690


Date   Description                          Debit      Credit
       Allowance for uncoll. acc.            310
          Bad debt expense                                  310
        Aging Of Receivables

   Balance sheet fairly valued
   Net A/R fairly estimated
   Income statement not fairly stated
   Expenses not matched to revenue
   Incorrect estimates from previous
    periods corrected
       Estimate Bad Debt Expense

   Estimate doubtful accounts expense
    with an adjusting journal entry

Date     Description                          Debit        Credit
         Bad debt expense                     ?,???
           Allowance for uncoll. acc.                          ?,???



       Assets          =      Liabilities +           Equity
                                                      
            Writing Off Accounts

   Write-off $1,000

Date     Description                          Debit        Credit
         Allowance for uncollectible acc.     1,000
            Accounts receivable                                1,000




       Assets           =     Liabilities +           Equity
        
          Writing Off Accounts

                            Before                  After
                           Write-off             Write-off
Accounts receivable        $100,000    - 1,000    $99,000

Less allowance                5,000    - 1,000      4,000

Accounts receivable, net    $95,000               $95,000
   Estimates And Actual

AJE Doubtful Acc. Exp. (Estimated)

Write-off account receivable (Actual)

       Allowance for Uncoll Acc

          Actual    Estimated
       Collect Account Written-Off

                      Reverse write-off

Date    Description                       Debit   Credit
        Accounts receivable               1,000
          Allowance for uncollect. acc.           1,000


         Record collection of receivable

Date    Description                       Debit   Credit
        Cash                              1,000
          Accounts receivable                     1,000
           Sale On Account

                        A    L   SE
Accounts receivable     
  Sales                          
     Collect Cash On Account

                        A   L   SE
Accounts receivable     
  Sales                         
Cash                    
  Accounts receivable   
       AJE Estimate Doubtful
        Accounts Expense
                                A   L   SE
Accounts receivable             
  Sales                                 
Cash                            
  Accounts receivable           
Doubtful accounts expense               
  Allowance for doubtful acc.   
           Write-off Account

                                 A   L   SE
Accounts receivable              
   Sales                                 
Cash                             
   Accounts receivable           
Doubtful accounts expense                
   Allowance for doubtful acc.   
Allowance for doubtful acc.      
   Accounts receivable           
Account Activity

 Accounts receivable
                               Asset
   Sales       Returns
              Collections
              Write-offs


 Allow Uncollectible
                            Contra asset
 Write-offs    AJE Est.
       Learning Objectives

 Recognition of notes receivable
 Valuation of notes receivable
             Notes Receivable

   Written contract
   From borrower to lender
   Negotiable (may be sold)
   Promise to pay
       From borrower (maker) to lender (payee)
       Principal (amount borrowed)
       Plus interest (stated or unstated)
       On date
      Notes Receivable vs. A/R

 Compared to accounts receivable
     Dollar amount higher
     Payment terms longer
     Higher risk of default
     Earn interest on outstanding balance
 Legal contract
 Easier to enforce in court
       Why Notes Receivable?

   Customers extend payment period
   High-risk or new customers
   Sales of property, plant, and equipment
   Lending transactions (majority of notes)
     Loans to employees, subsidiaries, vendors
                 Notes Receivable
                                                        Date of
                       PROMISSORY NOTE                   Note

  $25,000                                          Nov. 1, 2011
Face Value      Term                                   Date
  One year after date        I   promise to pay to the order of
                                        Payee
   Principal              Westward, Inc.
  Twenty-five thousand and no/100------------------------ Dollars
plus interest at the annual rate of 12% .              Maker

                       Interest Rate
                                       Janet Lee , Winn,Co.
         Interest Computation

  Principal × Interest rate × Time = Interest

               Rate is rate per year
        Time is years or fractions of years

       If time ≤ one year, simple interest
 If time > one year, compound interest (TVM)
Home / Broad Transactions / 835 Interest / 30 Imputation of Interest
November 1, 2011: Loan $25,000, 12%, one year
Journal entries November 1, December 31, 2011

                     Entry to record receivable
Date     Description                               Debit    Credit
Nov 1    Note receivable                          25,000
            Cash                                           25,000



 Adjusting journal entry to accrue interest: $25,000 × 12% × 2/12
Date     Description                               Debit    Credit
Dec 31   Interest receivable                        500
            Interest revenue                                  500
November 1, 2011: Loan $25,000, 12%, one year
 Journal entry on due date, November 1, 2012

            Entry to record collection of receivable
Date    Description                           Debit    Credit
Nov 1   Cash                                 28,000
          Note receivable                              25,000
          Interest receivable                            500
          Interest revenue                              2,500


            $25,000 × 12% × 10/12 = $2,500
  Non-Interest-Bearing Notes

 Actually do bear interest
 Interest is deducted (discounted) from
                 of
  the face value  the note
 Use market rate of interest
 Face value = Principal + interest
 Cash received = Face value − interest
  Non-Interest-Bearing Notes

 Discount is future interest revenue
 Discount is contra account to
  notes receivable
December 31, 2011, accepted $25,000, one-year
 non-interest-bearing, note discounted at 12%

          Entry to record acceptance of note receivable
            Discount = $25,000 × 0.12 × 1 = $3,000
Date     Description                          Debit       Credit
Dec 31   Note receivable                     25,000
2011       Discount on note receivable                     3,000
           Cash                                           22,000
   Non-Interest-Bearing Notes
                   Balance Sheet
                 December 31, 2011
Note receivable                                $25,000
Discount on note receivable                      3,000
Net note receivable                            $22,000

 Discount is revenue to be recognized in future periods
December 31, 2011, accepted $25,000, one-year
 non-interest-bearing, note discounted at 12%

          Entry to record acceptance of note receivable
            Discount = $25,000 × 0.12 × 1 = $3,000
Date     Description                            Debit      Credit
Dec 31   Note receivable                       25,000
2011       Discount on note receivable                      3,000
           Cash                                            22,000

           Entry to record collection of note receivable
Date     Description                            Debit      Credit
Dec 31   Cash                                  25,000
2012     Discount on note receivable            3,000
           Interest revenue                                 3,000
           Note receivable                                 25,000
  Notes Received in Exchange
 for Property, Goods, Services
 In arm’s length bargained transaction
  stated rate is presumed fair unless
   No interest rate is stated
   Stated interest rate is unreasonable
   Face amount of the note is materially
    different from the current cash sales price
 Stated rate not fair, use better known of
   FMV of goods, services or note itself
   Impute interest rate (estimate market rate)
       Notes Receivable for Land

   Accepted five-year note, maturity value
    of $35,000, no stated interest rate, in
    exchange for land
   Land fair market value: $20,000
   Land cost: $14,000
Description                             Debit   Credit
Note receivable                        35,000
  Discount on note receivable (plug)            15,000
  Land                                          14,000
  Gain on sale of land                           6,000
          Notes Receivable

 Short-Term
  Record at face value, less allowance
 Long-Term
  Record at present value of cash
  expected to be collected

Operating cycle determines short-term or long-term
    Note Issued at Face Value
 Lend $10,000 in exchange for $10,000,
  three-year note, 10% annual interest
 Market rate 10%
 Issued at par (market rate = stated rate)
              i = 10%
                                $10,000 Principal


        $1,000          1,000     1,000 Interest


0         1              2          3               4
              n=3
    Note Issued at Face Value
PV of Interest




    Annuity      PV$1 Ord Ann   Present value
  $1,000 ×        2.48685 =        $2,487
     Note Issued at Face Value
PV of Principal




    Principal        PV$1     Present value
  $10,000 ×       0.75132 =      $7,513
         Note Issued at Face Value
    Calculation of present value of note receivable
 Present value of principal                   $ 7,513
 Present value of interest                                    2,487
 Present value of note receivable                          $ 10,000
   Creation of note receivable at par (face value), interest rate 10%
Date      Description                              Debit          Credit
Jan 1     Note receivable                         10,000
            Cash                                                  10,000

 Annual interest revenue earned and cash collected, interest rate 10%
Date      Description                              Debit          Credit
Dec 31    Cash (10,000 × 10% × 1)                  1,000
            Interest revenue                                       1,000
         Note Issued at Face Value
        Beginning      Interest        Cash          Ending
         Balance       Revenue        Received       Balance
0                                                    10,000
1         10,000         1,000         1,000         10,000
2         10,000         1,000         1,000         10,000
3         10,000         1,000         1,000         10,000
                         3,000         3,000

Interest revenue = Beginning balance × market rate × time

    Cash received (annuity) = Face value × stated rate × time
       Zero-Interest-Bearing Note

     Receive a three-year, $10,000 zero-
      interest-bearing note
     Market rate of interest 9%
                     i = 9%
                                   $10,000 Principal


                $0            $0    $0 Interest


0           1                 3     3              4
                     n=3
    Zero-Interest-Bearing Note
PV of Principal




    Principal        PV$1     Present value
  $10,000 ×       0.77218 =      $7,722
Zero-Interest-Bearing Note

Year    Beg bal   Interest 9%   End bal
 0                               7,722
 1       7,722       695         8,417
  2      8,417       758         9,174
  3      9,174       826        10,000
Total               2,278
        Zero-Interest-Bearing Note
        Year            Beg bal        Interest 9%         End bal
          0                                                     7,722
          1               7,722               695               8,417
          2               8,417               758               9,174
          3               9,174               826              10,000
        Total                              2,278

                 Entry to record creation of note receivable
Date      Description                                 Debit         Credit
Jan 1     Note receivable                            10,000
                Discount on note receivable                             2,278
                Cash                                                    7,722
         Zero-Interest-Bearing Note
     Year            Beg bal        Interest 9%        End bal
       0                                                   7,722
       1               7,722            695                8,417
       2               8,417            758                9,174
       3               9,174            826               10,000
     Total                              2,278

            Entry to record annual interest revenue earned
Date      Description                             Debit        Credit
Dec 31    Discount on note receivable              695
             Interest revenue                                      695
Interest-Bearing Note Discount

 Make loan and receive three-year,
  $10,000 note, 10% interest annually
 Market rate of interest 12%

                 i = 12%
                                   $10,000 Principal


        $1,000             1,000    1,000 Interest


0         1                  2        3                4
                  n=3
Interest-Bearing Note Discount
PV of Interest




    Annuity      PV$1 Ord Ann   Present value
  $1,000 ×        2.40183 =        $2,402
Interest-Bearing Note Discount
PV of Principal




    Principal        PV$1     Present value
  $10,000 ×       0.71178 =      $7,118
  Interest-Bearing Note Discount

      Calculation of discount on note receivable
 Face value of note                         $ 10,000
 Present value of note ($7,118 + $2,402)        9,520
 Discount                                   $     480

    Creation of note receivable; stated rate 10%, market rate 12%
Date    Description                              Debit         Credit
Jan 1   Note receivable                         10,000
           Discount on note receivable                              480
           Cash                                                 9,520
Interest-Bearing Note Discount

     Calculation of discount on note receivable
Face value of note                         $ 10,000
Present value of note ($7,118 + $2,402)        9,520
Discount                                   $     480

                   Balance sheet
Note receivable                           $ 10,000
Less discount on note receivable                 480
Net note receivable                        $   9,520
     Beginning   Interest    Cash      Discount     Discount   Ending
      Balance    Revenue    Received   Amortized   Remaining   Balance
0                                                     480       9,520
1      9,520      1,142      1,000       142          338       9,662
2      9,662      1,159      1,000       159          179       9,821
3      9,821      1,179      1,000       179           0       10,000
                  3,480      3,000       480

    Interest revenue = Beginning balance × market rate × time

    Cash received (annuity) = Face value × stated rate × time

       Discount amortized = Interest revenue − cash received

    Discount remaining = Previous discount − discount amortized

       Ending balance = Face value − discount remaining OR
      Ending balance = Previous balance + discount amortized
      Interest-Bearing Note Discount
     Beginning     Interest     Cash         Discount     Discount   Ending
      Balance      Revenue     Received      Amortized   Remaining   Balance
0                                                           480       9,520
1      9,520         1,142       1,000         142          338       9,662
2      9,662         1,159       1,000         159          179       9,821
3      9,821         1,179       1,000         179           0       10,000
                     3,480       3,000         480

      Annual annuity, interest revenue; stated rate 10%, market rate 12%
    Date       Description                               Debit       Credit
    Dec 31     Cash                                      1,000
               Discount on note receivable                142
                 Interest revenue                                     1,142
Interest-Bearing Note Premium

 Make loan and receive three-year,
  $10,000 note, 15% interest annually
 Market rate of interest 12%

                 i = 12%
                                   $10,000 Principal


        $1,500             1,500    1,500 Interest


0         1                  2        3                4
                  n=3
Interest-Bearing Note Premium
PV of Interest




    Annuity      PV$1 Ord Ann   Present value
  $1,500 ×        2.40183 =        $3,603
Interest-Bearing Note Premium
PV of Principal




    Principal        PV$1     Present value
  $10,000 ×       0.71178 =      $7,118
  Interest-Bearing Note Premium

      Calculation of discount on note receivable
 Face value of note                         $ 10,000
 Present value of note ($7,118 + $3,603)       10,721
 Premium                                    $     721

    Creation of note receivable; stated rate 15%, market rate 12%
Date    Description                              Debit         Credit
Jan 1   Note receivable                         10,000
        Premium on note receivable                 721
           Cash                                                10,721
Interest-Bearing Note Premium

     Calculation of discount on note receivable
Face value of note                         $ 10,000
Present value of note ($7,118 + $3,603)       10,721
Premium                                    $     721

                  Balance sheet
Note receivable                           $ 10,000
Add premium on note receivable                  721
Net note receivable                        $ 10,721
     Beginning   Interest    Cash      Premium      Premium    Ending
      Balance    Revenue    Received   Amortized   Remaining   Balance
0                                                     721      10,721
1     10,721      1,287      1,500       213          508      10,508
2     10,508      1,261      1,500       239          269      10,269
3     10,269      1,232      1,500       269           0       10,000
                  3,780      4,500       721

    Interest revenue = Beginning balance × market rate × time

    Cash received (annuity) = Face value × stated rate × time

      Premium amortized = Cash received − interest revenue

Premium remaining = Previous premium − premium amortized

      Ending balance = Face value + premium remaining OR
     Ending balance = Previous balance − premium amortized
      Interest-Bearing Note Premium
     Beginning      Interest    Cash      Premium      Premium     Ending
      Balance       Revenue    Received   Amortized   Remaining    Balance
0                                                        721        10,721
1      10,721        1,287       1,500         213       508        10,508
2      10,508        1,261       1,500         239       269        10,269
3      10,269        1,232       1,500         269        0         10,000
                     3,780       4,500         721

      Annual annuity, interest revenue; stated rate 15%, market rate 12%
    Date        Description                           Debit         Credit
    Dec 31      Cash                                  1,500
                  Premium on note receivable                          213
                  Interest revenue                                  1,287
Valuation of Notes Receivable

 Short-Term
  Record at net realizable value (like A/R)
  NRV = Face value − less allowance
 Long-Term
  Record at present value of cash flows
   Disclose cost and fair value in notes
   Fair Value Option
    Can use fair value in financial statements
         Fair Value Option

 Optional, not required
 Make valuation decision (fair value or
  cost) when note receivable acquired
 Irrevocable: Cannot change valuation
  method during lifetime of note
          Fair Value Option

 If fair value option chosen:
   Change in fair value AJE each period
   Unrealized holding gains (losses) are
    “Other rev and exp” on income stmt
   Notes Receivable at Fair Value

   Notes receivable
       Fair value: $900,000
       Carrying amount (book value): $600,000
   Company selected fair value option
   Adjusting journal entry required
Description                           Debit    Credit
Note receivable                     300,000
  Unrealized holding gain or loss             300,000
       Learning Objectives

 Disposition of accounts and notes
  receivable
          Seller Financing

 Practice of seller financing to increase
  sales volume has grown over time
   GE Finance
   Caterpillar Finance
   Automobile financing
 Seller often does not hold receivable
 Immediately sells to convert to cash
             Terminology

 Secured borrowing (A/R as collateral)
   Assigning
   Pledging
 Factoring (Sale of receivables)
   Sale with recourse
   Sale without recourse
   Securitization
  Financing With Receivables

 Have receivable, need cash
 How do we convert receivable to cash?
 Two types of financing with receivables
   Secured borrowing (A/R used as collateral)
   Factoring (Sale of receivables)
 Method depends on the surrender of
  control over the receivables transferred
      Three Conditions of Sale

All conditions must be met for sale
1. Receivables isolated from seller
2. Buyer has right to pledge or exchange
    receivables
3. Seller does not have control
     Cannot repurchase before maturity
     Cannot require return of receivables
Secured Borrowing: Assigning

 Use of specific receivables as collateral
 If fail to repay debt, proceeds from
  specific accounts receivable collections
  used to repay debt
 On balance sheet reclassify specific
  accounts receivable as
  “Accounts Receivable Assigned”
 Secured Borrowing: Pledging

 Receivables in general pledged as
  collateral for loans
 Pledged receivables disclosed in notes
  to financial statements
 No change in journal entries, financial
  statement presentations
 Receivables transferred to custodian
                Assignment of
              Accounts Receivable
     December 1, 2011, borrow $500,000
     Interest rate 12%, payable monthly
     Assigned $620,000 of A/R as collateral
     Collateral > note reduces risk to lender
     Finance fee: 1.5% of A/R assigned
Description                                        Debit    Credit
Cash (plug)                                      490,700
Finance charge expense (1.5% × $620,000)           9,300
  Liability – financing arrangement [Note pay]             500,000
           Assignment of
         Accounts Receivable
                       Balance Sheet
                     December 1, 2011
Accounts receivable assigned                    $620,000
Less: Liability – financing arrangement          500,000
Equity in accounts receivable assigned          $120,000

Current asset shown net of current liability (rarely done)
                Assignment of
              Accounts Receivable
   During December, 2011
       Collect $400,000 in accounts receivable
       Remit $400,000 to lender plus interest
Description                                      Debit    Credit
Cash                                           400,000
   Accounts receivable                                   400,000


Interest expense ($500,000 × 12% × 1/12)         5,000
Liability – financing arrangement [Note pay]   400,000
   Cash                                                  405,000
           Assignment of
         Accounts Receivable
                       Balance Sheet
                     December 31, 2011
Accounts receivable assigned               $220,000
Less: Liability – financing arrangement     100,000
Equity in accounts receivable assigned     $120,000

Accounts receivable assigned = $620,000 – 400,000
                 Factoring

 A factor is a financial institution that
   Buys receivables for cash
   Handles billing, collection of receivables
   Charges a fee for the service

          http://www.californiafactors.com/
               2. Accounts Receivable
 SUPPLIER                               RETAILER
(Transferor)
                   1. Merchandise




                      FACTOR
                    (Transferee)
   With or Without Recourse

 Without recourse
   Buyer assumes all risk of uncollectibility
   Most sales without recourse
 With recourse
   Seller retains risk of uncollectibility
   Seller guarantees buyers will be paid
   Record the estimated fair value of the
    recourse obligation as a liability
         Sale of Receivables

   Control of receivable passes to factor
   A/R removed from sellers books
   Cash paid from buyer to seller
   Financing expense (or loss) recognized
      Sale of A/R Without Recourse

     Sold $600,000 of A/R without recourse
     Buyer immediately remits 90% in cash
     Buyer charges 4% of A/R sold as fee
     Buyer retains 6%, paid after collections
       Estimate of returns and discounts
Description                                     Debit    Credit
Cash (90% × $600,000)                         540,000
Loss on sale of receivables (4% × $600,000)    24,000
Receivable from factor (6% × $600,000)         36,000
  Accounts receivable                                   600,000
       Sale of A/R With Recourse
     Sold $600,000 of A/R with recourse
     Buyer immediately remits 90% in cash
     Buyer charges 4% of A/R sold as fee
     Buyer retains 6%, paid after collections
     Estimated recourse liability, $5,000
Description                                Debit    Credit
Cash (90% × $600,000)                    540,000
Loss on sale of receivables               29,000
(4%×$600,000)+5,000
Receivable from factor (6% × $600,000)    36,000
  Recourse liability                                 5,000
  Accounts receivable                              600,000
           Securitization

 Factor creates special purpose entity
  (SPE), usually trust or subsidiary
 SPE buys pool of trade receivables or
  loans from Factor
 SPE sells notes (bonds, comm. paper)
  backed (collateralized) by receivables
 Discounting Note Receivable

 A note receivable can be used to obtain
  immediate cash from a financial
  institution either by pledging note as
  collateral for a loan or selling note
 Selling note is called discounting
 Discounting Note Receivable

 The financial institution accepts note
  and gives seller cash equal to maturity
  value of note reduced by a discount
 Discount is computed by applying a
  discount rate to maturity value
 Discount represents financing fee
  financial institution charges for
  transaction
 Discounting Note Receivable

 On December 31, Apex accepted a
  nine-month, 10% note for $200,000
 Three months later on March 31, Apex
  discounted the note at its local bank
 The bank’s discount rate was 12%
            Step 1: Accrue Interest

   Accrue interest during period held
       Face value of note, $200,000
       Time, three months (Dec 31 – Mar 31)
       Interest rate on note, 10%

             $200,000 × 10% × 3/12 = $5,000

Description                             Debit   Credit
Interest receivable                     5,000
   Interest revenue                             5,000
    Step 2: Calc Maturity Value

 Calculate maturity value of note
    Face value of note, $200,000
    Time, nine months
    Interest rate on note, 10%

        $200,000 × 10% × 9/12 = $15,000

Face value                            $200,000
Interest to maturity                    15,000
Maturity value                        $215,000
   Step 3: Calc Cash Proceeds

 Discount maturity value of note
    Discount rate on note, 12%
    Time period of discount, six months

        $215,000 × 12% × 6/12 = $12,900

Maturity value                         $215,000
Less discount                            12,900
Cash proceeds                          $202,100
     Step 4: Record Journal Entry

Description                                Debit    Credit
Cash (Step 3)                            202,100
Loss on sale of note receivable (plug)     2,900
   Note receivable (Given)                         200,000
   Interest receivable (Step 1)                      5,000
     Classifying Receivables

 Segregate different types of receivables
 Use valuation accounts as needed
  (Allowance for uncollectibles, returns)
 Determine if current or non-current
 Disclose loss contingencies
 Disclose A/R pledged as collateral
 Disclose concentrations of credit risk
       Learning Objectives

 Reporting and analyzing receivables
Accounts Receivable Turnover

How many times do we collect average
      receivables during year



   A/R            Net sales
turnover   =
                 Average A/R
Accounts Receivable Turnover

How many times do we collect average
      receivables during year



   A/R                 Net sales
turnover   =

               (   Beg A/R + End A/R
                           2
                                       )
      Days To Collect A/R

How many days to collect $1 of A/R


 Days to                365
collect A/R   =
                   A/R turnover
           Cash Controls

 Management faces two problems in
  accounting for cash transactions
   Establish proper controls to prevent
    unauthorized transactions by officers or
    employees
   Properly manage cash on hand and cash
    transactions
              Cash Controls

 Physical Protection of Cash Balances
     Minimize the cash on hand
     Keep funds in a safe
     Transmit each day’s receipts to the bank
     Reconcile general ledger and bank
      balance
               Petty Cash

   Small amount of cash on hand ($100)
   Reimburse for small purchases
   Voucher, receipt required for payment
   Under control of petty cash custodian
   Replenished when below minimum
                          Petty Cash
          Petty cash fund created (check written on bank account)
Date        Description                             Debit           Credit
Jan 1       Petty cash                               100
               Cash                                                   100


        Petty cash fund replenished (check written on bank account)
Date        Description                             Debit           Credit
Jan 31      Office supplies expense                   25
            Postage expense                            50
            Employee food expense                      20
               Cash                                                    95
            Cash Short and Over

  Income statement account
  Debit decreases, credit increases N/I
  Difference between actual cash and
   amount per independent records
 Reconciliation of cash drawer, cash collected should equal cash sales
Date     Description                                  Debit     Credit
May 10   Cash (actual increase in cash drawer)         820
         Cash short and over                               5
            Sales (cash sales per register tape)                   825
       Bank Reconciliation

 Explains difference between cash
  reported on bank statement and cash
  balance on company’s books (G/L)
 Provides information for adjusting
  journal entries
       Bank Reconciliation

 Book, bank balances differ because of
  timing differences
 Cash moves through books at a
  different time than through bank
       Bank Reconciliation

 Important internal control procedure
 Two records of transactions: book, bank
 Identifies all cash inflow and outflows
         Bank Reconciliation
     Bank Balance           Book Balance


+ Deposits in Transit   + Bank Collections


                        - Service Charges
- Outstanding Checks
                        - NSF Checks


± Bank Errors           ± Book Errors


= True Cash Balance     = True Cash Balance
       Bank Reconciliation
                            Book Balance
         All
  Balance per Bank

  reconciling
                        + Bank Collections
 items on the
+ Deposits in Transit

   book side            - Service Charges
   require an
- Outstanding Checks    - NSF Checks
   adjusting
  entry to
± Bank Errors the       ± Book Errors

cash account.
= Adjusted Balance      = True Cash Balance
       Bank Reconciliation

 May 31 bank statement, $34,680
 Cash G/L account, $35,276
     Bank Reconciling Items

 May 31 bank statement, $34,680
 Total unrecorded deposits, $3,985
   Unrecorded cash deposits, $2,965
   $1,020 check mailed to the bank for
    deposit had not reached bank
 Outstanding checks totaled $5,536
      Bank Reconciling Items
     Bank to Corrected Balance Reconciliation
Bank balance, May 31                       $34,680
Add: Deposits in transit                      3,985
Deduct: Outstanding checks                  (5,536)
True cash balance                          $33,129
     Book Reconciling Items

 Cash G/L account, $35,276
 On bank statement
   $80 service charge on bank statement
   Bank returned NSF checks, $2,187
   Bank collected a note receivable for $1,120
    that included $120 of interest
 Error found: Check written for $1,790
  was erroneously recorded at $790
      Book Reconciling Items
      Book to Corrected Balance Reconciliation
Book balance, May 31                        $35,276
Add: Note collected by bank                    1,000
Add: Interest collect by bank                    120
Deduct: Bank service charges                     (80)
Deduct: NSF checks                           (2,187)
Deduct: Correction of book error             (1,000)
True cash balance                           $33,129
     Bank to Corrected Balance Reconciliation
Bank balance, May 31                      $34,680
Add: Deposits in transit                    3,985
Deduct: Outstanding checks                  5,536
True cash balance                         $33,129

     Book to Corrected Balance Reconciliation
Book balance, May 31                       $35,276
Add: Note collected by bank                     1,000
Add: Interest collect by bank                     120
Deduct: Bank service charges                      (80)
Deduct: NSF checks                         (2,187)
Deduct: Correction of book error           (1,000)
True cash balance                         $33,129
            Book to Corrected Balance Reconciliation
 Book balance, May 31                                  $35,276
 Add: Note collected by bank                             1,000
 Add: Interest collect by bank                            120
 Deduct: Bank service charges              AJE            (80)
 Deduct: NSF checks                                    (2,187)
 Deduct: Correction of book error                      (1,000)
 True cash balance                                     $33,129

Description                                   Debit       Credit
Cash                                          1,120
  Note receivable                                          1,000
  Interest revenue                                           120

Bank service charge                              80
Accounts receivable                           2,187
Accounts payable                              1,000
  Cash                                                     3,267
  Impairments of Receivables

 Companies evaluate receivables to
  determine collectability
 Allowance method is appropriate when:
   Probable asset has been impaired
   Amount of loss reasonably estimated
  Impairments of Receivables

 Impairment loss difference between
   Investment in loan (principal + accrued int)
   Expected future cash flows discounted at
    loan’s historical effective interest rate
 $100,000 note, 10% annual interest payment, 3 year life




Adjusting journal entry to record loss on impairment of note receivable
Date     Description                                  Debit      Credit
AJE      Bad debt expense                            12,437
            Allowance for doubtful accounts                      12,437
End of Chapter

				
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