INTERMEDIATE
ACCOUNTING
Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College
CHAPTER
7
Financial Assets:
Cash and Receivables
Learning Objectives
1. Identify items considered cash.
2. Indicate how cash and related items are
reported.
3. Define receivables and identify the different
types of receivables.
4. Explain accounting issues related to
recognition of accounts receivable.
5. Explain accounting issues related to
valuation of accounts receivable.
Learning Objectives
6. Explain accounting issues related to
recognition of notes receivable.
7. Explain accounting issues related to
valuation of notes receivable.
8. Explain accounting issues related to
disposition of accounts and notes receivable.
9. Explain how receivables are reported and
analysed.
Cash and Receivables
Cash
What is cash?
Management and
control of cash
Reporting cash
Summary of cashrelated items
Receivables
Recognition of accounts
receivable
Valuation of accounts
receivable
Recognition of notes
receivable
Valuation of notes
receivable
Disposition of accounts and
notes receivable
Presentation and analysis
Section 1:
Cash
Cash and Cash Equivalents:
Issues
• Cash
– various items comprise cash
• Management and control of cash
– the importance of internal control of cash
• Reporting of cash in the balance sheet
Items comprising “Cash”
• Cash must be readily available and be free of
restrictions
• Cash consists of coins, currency and available
funds
• Deposits (CDs) and short-term paper are
classified as temporary investments
• Postdated cheques, travel advances and
stamps on hand are not classified as cash
Management and Control of
Cash
• Since cash is the most liquid asset,
internal control of cash is imperative
• Controls must prevent unauthorized use
of cash
• Management must have necessary
information for proper use of cash
Reporting of Cash
• The reporting of cash depends upon
whether it is:
1.
2.
3.
4.
restricted cash
cash in foreign currencies
bank overdraft
cash equivalent
Restricted Cash
Compensating balances:
• Cash balance amounts maintained by a corporation
in support of existing borrowing arrangements
• Give the bank use of the restricted balance (funds
are not available for use by the corporation)
• Classified as current assets separate from cash, if
they relate to short-term loans
• Classified as non-current assets separate from cash,
if they relate to long-term loans
• Note disclosure includes the nature of the financial
arrangement and cash restriction
Foreign Currencies
• Amount held is reported in Canadian
dollars
• Exchange rate used is the rate in effect
on balance sheet date
• If restrictions exist on the foreign funds,
those funds are reported as restricted
Bank Overdrafts
• Overdrafts represent cheques written in
excess of cash account balance
• Overdrafts are reported as current liabilities
• Overdrafts may be offset against available
cash in another account in the same bank
• Otherwise, such offsetting is not allowed
Cash Equivalents
• Short-term, highly liquid investments
• Can be converted to a known amount of cash
• Maturity date is generally three months or
less
• Examples:
– Treasury bills
– Commercial paper
– Money market funds
Section 2:
Receivables
Accounts Receivable – Issues
• Types of accounts receivable
– Current and non-current
– Trade receivables
• Accounts receivable
• Notes receivable
– Non-trade receivables
• Recognition and valuation of accounts receivable
–
–
–
–
Trade discounts
Cash discounts
Uncollectible accounts
Sales returns and allowances
• Recognition and valuation of notes receivable
• Disposition of receivables
Accounts Receivable:
Recognition
• Trade (quantity) discounts are not
recorded
• Cash (sales) discounts are inducements
to customers for prompt payment of
amounts billed
• Cash discounts are normally recorded
and appear in books as a reduction of
sales revenue
Accounts Receivable:
Recording Cash Discounts
• There are two methods:
– Gross
– Net
• Gross method records discounts when
taken by customers
• Net method records discounts not taken
by customers
Accounts Receivable: Recording
Cash Discounts
Gross Method
Net Method
• Record revenue at gross
amount of sales
• Record revenue at gross
amount of sales less
cash discount
• When customer forfeits
discount, record
discounts not taken
• Report discounts
forfeited as other
revenue
• When customer takes
the discount, record
cash discounts
• Cash discounts reduce
gross sales revenue
Valuation of Accounts
Receivable
• Short term receivables are reported at
their net realizable value (NRV)
• The NRV is the net amount expected to
be collected
• The NRV is gross accounts receivable
less estimated uncollectible accounts
Estimating Uncollectible
Receivables
Methods
Direct Write-Off
Allowance
1 Not based on the matching
principle
Based on the matching
principle
2 Accounts are written-off
when determined uncollectible
Estimated bad debts are
matched against revenue
3 Appropriate only if
amounts are not material
Must be followed if
amounts are material
Estimating Uncollectible Accounts:
The Allowance Method
•
The estimate of uncollectible accounts may
be based on:
1. percentage of sales (or net sales)
2. outstanding accounts receivable
•
•
These approaches are referred to as
Income Statement and Balance Sheet
approaches (respectively)
Both methods use an Allowance for
Doubtful Accounts (contra account)
The Income Statement Approach
• Uses the relationship between sales and
bad debts
• Matches the sales generated to the cost
of bad debts estimated
• Any existing balance in the Balance
Sheet account (Allowance for Bad
Debts) is ignored when calculating the
current year expense
The Income Statement Approach
Example:
• Dockrill Corp. reports the following
balances for the year 2000 (first year):
– Credit sales:
$400,000
• The company estimates bad debts at
2% of net sales
• Determine estimated uncollectible
accounts expense for 2000
The Income Statement Approach
1 Est. uncollectible accounts (bad debts) expense:
$400,000 * 2% = $8,000
2 To record bad debts expense:
Bad Debts expense
$8,000
Allowance for Doubtful Accounts
$8,000
3 Regardless of the existing balance in the Allowance
for Doubtful Accounts general ledger account, the
Bad Debts Expense for the year is $8,000
The Balance Sheet Approach
• Uses past collection experience to estimate bad
debt expense
• Focus is on providing an estimate of accounts
receivable value
– Does not focus on matching sales to bad debt expense
• Any existing balance in Allowance for Doubtful
Accounts is used to calculate the current year’s
bad debt expense
• Two methods of calculation
– Composite (single) rate
– Aged receivable analysis
The Balance Sheet Approach –
Composite Rate
Example:
• Wilson & Co. reports the following year-end
balances for the year 2000:
– Accounts Receivable:
– Allowance for Doubtful
Accounts
$547,000
$
800
• The company estimates bad debts at 10% of
accounts receivable
• Determine estimated uncollectible accounts
expense for 2000
The Balance Sheet Approach –
Composite Rate
1 Calculate the required Allowance Account balance:
$547,000 * 10% = $54,700
$ 54,700 - $800
= $53,900
2 To record bad debts expense:
Estimated bad debts expense
53,900
Allowance for Uncollectible accounts 53,900
Bad debts expense
2000: 53,900
Allowance
Dec. 31
Adjusting entry
Year end balance
800
53,900
54,700
The Balance Sheet Approach –
Aged Receivable Analysis
Wilson & Co. – Aging Schedule
Customer
Balance
< 60
Days
Western
$ 98,000
$ 80,000
Brockway
320,000
320,000
Freeport
55,000
Allegheny
74,000
91 – 120
Days
> 120 Days
$ 18,000
55,000
60,000
$547,000 $460,000
Estimated
Uncollectibl
e
61 – 90
Days
4%
14,000
$ 18,000
15%
$ 14,000
20%
$ 55,000
25%
The Balance Sheet Approach –
Aged Receivable Analysis
1 Calculate uncollectible accounts (bad debts) expense:
460,000 * .04
$18,400
18,000 * .15
2,700
14,000 * .20
2,800
55,000 * .25
13,750
Required balance in the
Allowance for Doubtful Accounts
$37,650
Less: Current Balance
800
Bad Debts Expense
$36,850
2 To record bad debts expense:
Estimated bad debts expense
36,850
Allowance for Uncollectible accounts
36,850
The Allowance Method (Acct.
Rec. Approach - Second Year)
Bad debts expense
36,850
Allowance
Adjusting entry:
Bad Debts expense
36,850
Allowance account
36,850
800
36,850
37,650
Required
ending
allowance
Balance Sheet Representation
• Short term accounts receivable are shown at
their net realizable value as follows:
Accounts Receivable (gross)
Less: Allowance
Net Realizable Value
$ XXX
_ XX
$ XX
Writing Off Accounts Receivable
Allowance Method
• Dr. Allowance for Doubtful Accounts
Cr. Accounts Receivable
(for the amount to be written off)
•
Bad Debts Expense is not used
• If the account is collected, after being written
off, then:
Dr. Accounts Receivable
Cr. Allowance for Doubtful
Accounts
(for the amount collected)
Dr. Cash
Cr. Accounts Receivable
(for the amount collected)
Writing Off Accounts Receivable
Direct Method
• Dr. Bad Debts Expense
Cr. Accounts Receivable
(for the amount to be written off)
• If the account is collected, after being written
off, then:
Dr. Accounts Receivable
Cr. Uncollectible Amounts Recovered
(for the amount collected, with note
on A/R sub ledger)
Revenue Account
Section 3:
Notes Receivable
Notes Receivable: Issues
• Recognition of notes receivable
– Issues at face value and issues not at
face value
– Issues for cash / non-cash considerations
• Valuation issues
• Disposition of notes receivable
Recognition of Notes Receivable
Notes Receivable
Short term N/R
Record at face value
less Allowance
Long term N/R
Record at present value
of cash expected to
be collected
Issues at par
Issues not at par
Recognition of Notes Receivable
• Notes receivable are issued at face
value when the stated rate of interest is
the same as the effective (market) rate
• When the rates are unequal, a discount
on the note results
• The discount is amortized to interest
revenue by the effective interest
method
Recognition of Notes
Receivable
Issues NOT at face value
Non-interest bearing
1. Determine discount on
notes receivable at
implicit rate of interest
2. The discount is
amortized to interest
revenue by the
effective interest
method
Interest bearing
1. Determine discount on
notes receivable at
the effective rate of
interest
2. The discount is
amortized to interest
revenue by the
effective interest
method
Discount on Notes Receivable
• Morgan Corp. issues a three-year note receivable
to Marie Co. in the amount of $10,000
• Stated Rate, 10%; Effective Rate, 12%
Face Value of the note
PV of the principal (face value)
n = 3, i = 12%
PV of the interest annuity
($10,000 * 10% = $1,000)n = 3, i = 12%
PV of the Note
Difference (= Discount)
$10,000
$7,118
$2,402
$ 9,520
$ 480
Discount on Notes Receivable
Date Note is Signed:
Notes Receivable
10,000
Discount on Notes Receivable
480
Cash
9,520
Date Note is Collected:
Discount (N/R)
142
Cash
1,000
Interest Revenue
1,142
Discount of Notes Receivable
• Discount is amortized using the
effective interest method
• Amortized over the life of the note
• Straight-line method available only if
the difference between effective
interest and straight line method are
immaterial
Section 4:
Disposition of Accounts
and
Notes Receivable
Disposition of Accounts and
Notes Receivable
• The holder of accounts or notes receivable
may transfer them for cash
• The transfer may be:
–
–
secured borrowing
a sale of receivables
• Holder retains ownership of receivables in a
secured borrowing transaction
• Holder transfers ownership of receivables in a
sale (retaining risks of collection)
Transfer of Receivables:
Borrowing vs. Sale Treatment
Conditions
1. Are transferred assets isolated
from transferor? and
2. Does transferee have right to
pledge or sell assets? and
3. Has transferor divested itself of
control through repurchase
agreement?
Yes
Sale
No
Borrowing
Accounting for Transfers of
Receivables
Transfers
Sale
Secured Borrowing
With Recourse
Continuing involvement
by
seller
Without Recourse
No continuing
involvement by
seller
Secured Borrowing
(highlights)
• Transferor records a finance charge
• Transferor collects accounts receivable
• Transferor records sales returns and sales
discounts
• Transferor absorbs bad debts expense
• Transferor records interest expense on notes
payable
• Transferor pays on the note periodically from
collections
Sale of Receivables
• Transferor transfers ownership of receivables
to factor
• Factor records the (transferred) accounts as
assets in its books
• Transferor records any amount retained by
transferee as “due from factor”
• Transferor records loss on sale of receivables
• Transferor records any component liability
(when appropriate)