Sixth Canadian Edition
KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA; Grant MacEwan College

C H A P T E R
7
Financial Assets:
Cash and Receivables

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.

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
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

• Cash
– various items comprise cash
• Management and control of cash
– the importance of internal control of cash
• Reporting of cash in the balance sheet

• 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

• 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

• The reporting of cash depends upon whether it is:
1. restricted cash
2. cash in foreign currencies
3. bank overdraft
4. cash equivalent

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

• 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

• 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

• 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

• 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

• 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

• 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
• When customer takes the discount, record cash discounts
• Cash discounts reduce gross sales revenue
• Record revenue at gross amount of sales less cash discount
• When customer forfeits discount, record discounts not taken
• Report discounts forfeited as other revenue

• 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

Methods
Direct Write-Off
1 Not based on the matching principle
2
3
Allowance
Based on the matching principle
Accounts are written-off Estimated bad debts are when determined uncollectible matched against revenue
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: $547,000
– Allowance for Doubtful
Accounts $ 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. 31 800
Adjusting entry 53,900
Year end balance 54,700

The Balance Sheet Approach –
Aged Receivable Analysis
Wilson & Co. – Aging Schedule
Customer
Western
Balance < 60
Days
61 – 90
Days
$ 98,000 $ 80,000 $ 18,000
Brockway
Freeport
Allegheny
Estimated
Uncollectibl e
320,000
55,000
74,000
320,000
60,000
91 – 120
Days
$547,000 $460,000 $ 18,000 $ 14,000
4% 15%
14,000
20%
> 120 Days
55,000
$ 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
14,000 * .20
55,000 * .25
Required balance in the
2,700
2,800
13,750
Allowance for Doubtful Accounts $37,650
Less: Current Balance
Bad Debts Expense
800
$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
800
36,850
37,650
Adjusting entry:
Bad Debts expense 36,850
Allowance account 36,850
Required ending allowance

• Short term accounts receivable are shown at their net realizable value as follows:
Accounts Receivable (gross)
Less: Allowance
Net Realizable Value
$ XXX
_ XX
$ XX

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)

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

• 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

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

• Morgan Corp. issues a three-year note receivable to Marie Co. in the amount of $10,000
• Stated Rate, 10%; Effective Rate, 12%
$10,000 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%
$7,118
PV of the Note
Difference (= Discount)
$2,402
$ 9,520
$ 480

Date Note is Signed:
Notes Receivable 10,000
Discount on Notes Receivable 480
Cash 9,520
Date Note is Collected:
Discount (N/R)
Cash
Interest Revenue
142
1,000
1,142

• 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

• 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
No
Sale
Borrowing

Accounting for Transfers of
Receivables
Transfers
Secured Borrowing Sale
With Recourse Without Recourse
Continuing involvement by seller
No continuing involvement by seller

• 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

• 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)

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