Chapter
7
Cash and Receivables
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
LO7-1 Define what is meant by internal control and describe some key elements of an internal
control system for cash receipts and disbursements.
LO7-2 Explain the possible restrictions on cash and their implications for classification in the
balance sheet.
LO7-3 Distinguish between the gross and net methods of accounting for cash discounts.
LO7-4 Describe the accounting treatment for merchandise returns.
LO7-5 Describe the accounting treatment of anticipated uncollectible accounts receivable.
LO7-6 Describe the two approaches to estimating bad debts.
LO7-7 Describe the accounting treatment of short-term notes receivable.
LO7-8 Differentiate between the use of receivables in financing arrangements accounted for as
a secured borrowing and those accounted for as a sale.
LO7-9 Describe the variables that influence a company’s investment in receivables and
calculate the key ratios used by analysts to monitor that investment.
LO7-10 Discuss the primary differences between U.S. GAAP and IFRS with respect to cash and
receivables.
CHAPTER HIGHLIGHTS
PART A: CASH AND CASH EQUIVALENTS
Cash includes currency and coins, balances in checking accounts, and items acceptable for deposit
in these accounts, such as checks and money orders received from customers. Cash equivalents
include such things as certain money market funds, treasury bills, and commercial paper. To be
classified as cash equivalents, these investments must have a maturity date no longer than three
months from the date of purchase. Cash and cash equivalents usually are combined and reported as
a single amount in the current asset section of the balance sheet.
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Cash that is restricted in some way and not available for current use usually is reported as
investments and funds or other assets. For example, banks frequently ask borrowers to maintain a
specified balance in a low-interest or noninterest-bearing account at the bank. These are known as
compensating balances. The classification of these balances depends on the nature of the restriction
and the classification of the related debt.
U.S. GAAP and IFRS are similar with respect to accounting for cash and cash equivalents. One
difference relates to bank overdrafts, which occur when withdrawals from a bank account exceed
the available balance. U.S. GAAP requires that overdrafts typically be treated as liabilities. IFRS
allows bank overdrafts to be offset against other cash accounts.
Internal Control of Cash
A system of internal control refers to a company’s plan to (a) encourage adherence to company
policies and procedures, (b) promote operational efficiency, (c) minimize errors and theft, and (d)
enhance the reliability and accuracy of accounting data. Since cash is the most liquid asset and the
asset most easily expropriated, a system of internal control of cash is a key issue.
The Sarbanes-Oxley Act of 2002 requires that companies not only document their internal controls
and assess their adequacy, but that their auditors must provide an opinion on management’s
assessment. The Public Company Accounting Oversight Board’s Auditing Standard No. 2 further
requires the auditor to express its own opinion on whether the company has maintained effective
internal control over financial reporting
A critical aspect of an internal control system is the separation of duties. Employees involved in
recordkeeping should not also have physical access to assets. For example, in the cash area, the
employee or employees who receive checks and make deposits should not be the same as the
employee who enters the receipts in the accounting records. Periodic bank reconciliations and the
use of a petty cash system are other important control procedures involving cash. These two topics
are covered in the appendix to the chapter.
PART B: CURRENT RECEIVABLES
Receivables represent a company's claim to the future collection of cash, other assets, or services.
Accounts receivable result from the sale of goods or services on account. When a receivable, trade
or nontrade, is accompanied by a formal promissory note, it’s referred to as a note receivable.
Initial Valuation of Accounts Receivable
The typical account receivable is initially valued at the exchange price agreed upon by the buyer
and seller. Trade discounts are reductions in list prices of goods and services to arrive at the
exchange price. Cash discounts, often called sales discounts, on the other hand, reduce the agreed
upon exchange price if remittance is made within a specified short period of time. For example,
terms of 2/10,n/30 mean that a 2% discount is available to the buyer if paid within 10 days,
otherwise full payment is due within 30 days.
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There are two ways to record cash discounts, the gross method and the net method.
ILLUSTRATION
McQuire Company sold merchandise on credit. The invoice price was $5,000, subject to a 2%
cash discount if paid within 10 days.
To record the sale and cash collection using the Gross Method:
To record the sale:
Accounts receivable ............................................................................
Sales revenue ..................................................................................
5,000
To record cash collection if made within discount period:
Cash ....................................................................................................
Sales discounts (2% x $5,000) ................................................................
Accounts receivable .......................................................................
4,900
100
To record cash collection if made after discount period:
Cash ....................................................................................................
Accounts receivable .......................................................................
5,000
5,000
5,000
5,000
To record the sale and cash collection using the Net Method:
To record the sale:
Accounts receivable ............................................................................
Sales revenue ..................................................................................
4,900
To record cash collection if made within discount period:
Cash ....................................................................................................
Accounts receivable .......................................................................
4,900
To record cash collection if made after discount period:
Cash ....................................................................................................
Accounts receivable .......................................................................
Interest revenue (2% x $5,000) ...........................................................
4,900
4,900
5,000
4,900
100
Subsequent Valuation of Accounts Receivable — Sales Returns
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If sales revenue is recognized at delivery of a product, recognizing sales returns when they occur
could result in an overstatement of income in the period of sale. If returns are material, they should
be estimated and recorded in the same period as the related sale. This is accomplished by recording
adjusting journal entries at the end of an accounting period. For example, if at the end of 2013 a
company anticipated that returns in early 2014 from year 2013 sales would be $20,000
(merchandise cost $12,000), the following adjusting entries are recorded:
Sales returns ........................................................................................
Allowance for sales returns .............................................................
20,000
Inventory - estimated returns ..............................................................
Cost of goods sold ..........................................................................
12,000
20,000
12,000
Sales returns are a reduction in sales revenue and the allowance for sales returns is a contra account
to accounts receivable. When returns occur in the next period, the allowance account is reduced
(debited) and accounts receivable also is reduced (credited).
Subsequent Valuation of Accounts Receivable — Uncollectible Accounts Receivable
If material amounts of bad debts are anticipated, the allowance method should be used. The
allowance method attempts to estimate future bad debts and match them with the related sales
revenue. An adjusting entry records a debit to bad debt expense and a credit to allowance for
uncollectible accounts, a contra account to accounts receivable. Actually, bad debt write-offs
reduce both accounts receivable and the allowance account.
There are two ways commonly used to arrive at the estimate of future bad debts, the income
statement approach and the balance sheet approach. Using the income statement approach, we
estimate bad debt expense as a percentage of each period's credit sales. Using the balance sheet
approach, we determine bad debt expense by estimating the net realizable value of accounts
receivable to be reported in the balance sheet. In other words, the allowance for uncollectible
accounts is determined and bad debt expense is an indirect outcome of adjusting the allowance
account to the desired balance. An aging of accounts receivable often is used to determine net
realizable value.
ILLUSTRATION
The Zeltech Company uses the allowance method to account for bad debts. At the beginning of
2013, the allowance account had a credit balance of $23,000. Credit sales for 2013 totaled
$1,200,000 and the year-end accounts receivable balance was $245,000. During the year, $21,000
in receivables was determined to be uncollectible.
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The Income Statement Approach
Assuming that Zeltech anticipates that 3% of all credit sales will ultimately become uncollectible,
the following adjusting entries record the write-off of accounts receivable and bad debt expense:
Allowance for uncollectible accounts .................................................
Accounts receivable .......................................................................
21,000
Bad debt expense (3% x $1,200,000) .......................................................
Allowance for uncollectible accounts .............................................
36,000
21,000
36,000
Notice that in recording bad debt expense net realizable value was not a determining factor.
The Balance Sheet Approach
Assume that at the end of 2013, an aging of accounts receivable indicated a net realizable value of
$205,000. This means that the allowance account at the end of 2013 must have a credit balance of
$40,000 to reduce gross accounts receivable of $245,000 to net realizable value of $205,000. After
the year 2013 write-offs, the allowance account has a credit balance of only $2,000 ($23,000
beginning balance less write-offs of $21,000). Therefore, bad debt expense for 2013 is $38,000
($40,000 - 2,000).
Allowance for uncollectible accounts .................................................
Accounts receivable .......................................................................
21,000
Bad debt expense ................................................................................
Allowance for uncollectible accounts ($40,000 - 2,000).....................
38,000
21,000
38,000
Notice that the allowance account is determined directly, and bad debt expense is an indirect
outcome of adjusting the allowance account to the desired balance
Accounts receivable is reported in the balance sheet net of the allowance for uncollectible accounts.
Using the balance sheet approach from above, Zeltech would report the following in the current
asset section of the year 2013 balance sheet:
Accounts receivable
Less: Allowance for uncollectible accounts
Net accounts receivable
$245,000
(40,000)
$205,000
When a receivable that has been written off is subsequently collected, the receivable and allowance
should be reinstated. The collection is then recorded the usual way as a debit to cash and a credit to
accounts receivable.
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If uncollectible accounts are not anticipated or are immaterial, or if it's not possible to reliably
estimate uncollectible accounts, the allowance method need not be used. Any bad debts that do
arise simply are written off as bad debt expense. This approach is known as the direct write-off
method.
Notes Receivable
Notes receivable are formal credit arrangements between a creditor (lender) and a debtor
(borrower). Notes receivable are classified as either current or noncurrent depending on the
expected payment date(s).
Interest-Bearing Notes
The typical note receivable requires the payment of a specified face amount, also called principal,
and interest at a stated percentage of the face amount. These are referred to as interest-bearing
notes. Interest on notes is calculated as:
Face amount x Annual rate x Time to maturity
ILLUSTRATION
Masterson Carpet Company's fiscal year end is December 31. On March 31, 2013, the company
sold carpeting to Jacobsen Home Builders. Masterson agreed to accept a $300,000, 12-month, 10%
note in payment for the carpeting. Interest is payable at maturity. The following entries record the
note and related sales revenue, the accrual of interest on December 31, 2013, and the payment of
the note:
March 31, 2013
Note receivable ...................................................................................
Sales revenue .................................................................................
300,000
December 31, 2013
Interest receivable ...............................................................................
Interest revenue ($300,000 x 10% x 9/12) ............................................
22,500
March 31, 2014
Cash [$300,000 + ($300,000 x 10%)] ..........................................................
Interest revenue ($300,000 x 10% x 3/12) ............................................
Interest receivable ...........................................................................
Note receivable ..............................................................................
300,000
22,500
330,000
7,500
22,500
300,000
Noninterest-Bearing Notes
Sometimes a receivable assumes the form of a so-called noninterest-bearing note. The name is a
misnomer, though. Noninterest-bearing notes actually do bear interest, but the interest is deducted
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from the face amount to determine the cash proceeds available to the borrower at the outset. For
example, the Masterson Carpet Company note in the illustration on the previous page could be
packaged as a $300,000 noninterest-bearing note with a 10% discount rate. In that case, the
$30,000 of interest would be discounted at the outset and the selling price of the carpet would have
been $270,000.
March 31, 2013
Note receivable ...................................................................................
Discount on note receivable ($300,000 x 10%)...................................
Sales revenue .................................................................................
300,000
30,000
270,000
December 31, 2013
Discount on note receivable ...............................................................
Interest revenue ($300,000 x 10% x 9/12) ............................................
22,500
March 31, 2014
Discount on note receivable ................................................................
Interest revenue ($300,000 x 10% x 3/12) ............................................
7,500
Cash ....................................................................................................
Note receivable ..............................................................................
22,500
7,500
300,000
300,000
U.S. GAAP and IFRS treat accounts and notes receivable similarly. One difference is that U.S.
GAAP requires separate disclosure of accounts receivable from customers, from related parties, and
from others. IFRS does not have that requirement.
Financing With Receivables
Financial institutions have developed a wide variety of methods for companies to use their
receivables to obtain immediate cash. Despite this diversity, any of these methods can be described
as either:
1. A secured borrowing.
2. A sale of receivables.
Secured Borrowing
These arrangements basically involve the use of receivables as collateral for a loan. The receivables
stay on the balance sheet of the company, and they record a liability for the cash that they borrow.
You may already be familiar with the concept of assigning or pledging receivables as collateral if
you or someone you know has a mortgage on a home. The bank or other financial institution
holding the mortgage will require that, if the homeowner defaults on the mortgage payments, the
home be sold and the proceeds used to pay off the mortgage debt. Similarly, in the case of an
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assignment of receivables, nonpayment of a debt will require the proceeds from collecting the
assigned receivables to go directly toward repayment of the debt.
Usually, the amount borrowed is less than the amount of receivables assigned. The difference
provides some protection for the lender to allow for possible uncollectible accounts. Also, the
assignee (transferee) usually charges the assignor an up-front finance charge in addition to stated
interest on the collateralized loan. The receivables might be collected either by the assignor or the
assignee, depending on the details of the arrangement.
ILLUSTRATION
On November 1, 2013, the Weintrob Wholesale Fur Company borrowed $300,000 from a local
finance company and signed a promissory note. Interest at 10% is payable monthly. Weintrob
assigned $350,000 of its receivables as collateral for the loan. The finance company charges a
finance fee equal to 2% of the receivables assigned.
Weintrob records the borrowing as follows:
Cash (difference) ............................................................ 293,000
Finance charge expense* (2% x $350,000) .....................
7,000
Liability – financing arrangement .........................
300,000
Weintrob will continue to collect the receivables, record any discounts, sales returns, and bad debt
write-offs, but will remit the cash to the finance company, usually on a monthly basis. If $250,000
of the receivables assigned are collected in November, Weintrob records the following entries:
Cash............................................................................. 250,000
Accounts receivable ...............................................
250,000
Interest expense ($300,000 x 10% x 1/12) ........................
2,500
Liability – financing arrangement .............................. 250,000
Cash........................................................................
252,500
*In theory, this fee should be allocated over the entire period of the loan rather than recorded as expense in the initial
period. However, amounts usually are small and the loan period usually is short. For expediency, then, we expense
the entire fee immediately.
Sale of Receivables
The two most common types of selling arrangements are factoring and securitization. The basic
accounting treatment for the sale of receivables is similar to accounting for the sale of other assets. The
seller (transferor) (a) removes from the accounts the receivables (and any allowance for bad debts associated
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with them), (b) recognizes at fair value any assets acquired or liabilities assumed by the seller in the
transaction, and (c) records the difference as a gain or loss.
The specific accounting treatment for the sale of receivables depends on the amount of risk the
factor assumes, in particular whether it buys the receivables without recourse or with recourse.
When a company sells accounts receivable without recourse, the buyer assumes the risk of
uncollectibility. This means the buyer has no recourse to the seller if customers don’t pay the
receivables. In that case, the seller simply accounts for the transaction as a sale of an asset.
ILLUSTRATION
The Weintrob Wholesale Fur Company factors its accounts receivable to a local finance company.
On November 1, 2013, Weintrob factored $350,000 of accounts receivable. The transfer was made
without recourse. The finance company remits 90% of the factored receivables and retains 10%.
When the finance company collects the receivables, it remits to Weintrob the retained amount, less
a 4% fee (4% of the total factored amount). Therefore, under this arrangement the finance company
provides Weintrob with cash up front and a “beneficial interest” in the transferred receivables equal
to the fair value of the last 10% of the receivables to be collected (which Weintrob management
estimates to equal $30,000), less the 4% factoring fee. Weintrob records the transfer as follows:
November 1, 2013
Cash (90% x $350,000) ............................................................................
Loss on sale of receivables (to balance) .................................................
Receivable from factor ($30,000 fair value – 14,000 fee) ..........................
Accounts receivable (balance sold) ....................................................
315,000
19,000
16,000
350,000
When a company sells accounts receivable with recourse, the seller retains the risk of
uncollectibility. In effect, the seller guarantees that the buyer will be paid even if some receivables
prove to be uncollectible. In the above illustration, even if the receivables were sold with recourse,
as long as the three conditions for sale treatment are met, Weintrob would still account for the
transfer as a sale. The only difference would be the additional requirement that Weintrob record the
estimated fair value of the recourse obligation as a liability. The recourse obligation is the
estimated amount that Weintrob will have to pay the finance company as a reimbursement for
uncollectible receivables. Assuming that this amount is estimated at $5,000, the entry recorded by
Weintrob would be as follows:
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November 1, 2013
Cash (90% x $350,000) ............................................................................
Loss on sale of receivables (to balance) .................................................
Receivable from factor ($30,000 fair value – 14,000 fee)...........................
Recourse liability ...........................................................................
Accounts receivable (balance sold) ....................................................
315,000
19,000
16,000
5,000
350,000
Discounting a Note Receivable
The transfer of a note receivable to a financial institution is called discounting. The financial
institution accepts the note and gives the seller cash equal to the maturity value of the note reduced
by a discount. The discount is computed by applying a discount rate to the maturity value and
represents the financing fee the financial institution charges for the transaction. Similar to accounts
receivable, if the conditions for sale treatment are met, the transferor would account for the transfer
as a sale. If the conditions are not met, it is treated as a secured borrowing.
ILLUSTRATION
On January 31, 2013, the Weintrob Wholesale Fur Company lent a customer $100,000. The note
requires the payment of the principal amount plus interest at 8% on January 31, 2014. On April 30,
2013, Weintrob discounted the note at a local bank. The bank’s discount rate is 10%. The three
conditions for treatment as a sale are met. The appropriate journal entries are:
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January 31, 2013
Note receivable ....................................................................................
Cash.................................................................................................
100,000
100,000
April 30, 2013
Step 1 - Accrue interest earned on the note prior to its being discounted.
Interest receivable ................................................................................
2,000
Interest revenue ($100,000 x 8% x 3/12) ..............................................
2,000
Steps 2 and 3 - Add interest to maturity to calculate maturity value and deduct
discount to calculate cash proceeds.
$100,000
Face amount
8,000
Interest to maturity ($100,000 x 8%)
108,000
Maturity value
(8,100)
Discount ($108,000 x 10% x 9/12)
$ 99,900
Cash proceeds
Cash (proceeds determined above) .............................................................
Loss on sale of note receivable (difference) ..........................................
Note receivable (face amount) ...........................................................
Interest receivable (accrued interest determined above) .........................
99,900
2,100
100,000
2,000
Choosing Between Accounting as a Secured Borrowing or a Sale of Receivables
Companies tend to prefer to treat transfers of receivables as sales, as that treatment moves the
receivables and liability off balance sheet and may allow recognition of gains on the transfer.
Therefore, there are restrictions on whether a transfer can be treated as a sale. The critical element
is the extent to which the company (the transferor) surrenders control over the assets transferred.
The transferor is determined to have surrendered control over the receivables if and only three
conditions are met:
a. The transferred assets have been isolated from the transferor—beyond the reach of the
transferor and its creditors.
b. Each transferee has the right to pledge or exchange the assets it received.
c. The transferor does not maintain effective control over the transferred assets.
If these conditions are met, the transferor treats the transaction as a sale. If these conditions are not
met, the transferor treats the transaction as a secured borrowing. In that case the company records a
liability with the receivables serving as collateral.
Recent changes in GAAP make is harder for transfers to count as sales. For example, many types
of securitizations must now be consolidated, and so end up treated as secured borrowings. Also, if
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the transfer is only of part of a receivable, that part has to qualify as a “participating interest”,
which is restrictive and therefore unlikely to allow sales treatment.
U.S. GAAP and IFRS will often treat transfers similarly. However, the rules by which they
distinguish between accounting for a transfer as a sale or as a secured borrowing differ somewhat.
U.S. GAAP focuses on control of the asset. IFRS focuses first on rights to cash flows and whether
risks and rewards of ownership have transferred, but also considers control under some
circumstances.
Decision Makers' Perspective
A company's investment in receivables is influenced by several variables, including the level of
sales, the nature of the product or service sold, and credit and collection policies. Management
must evaluate the costs and benefits of any change in credit and collection policies. The ability to
use receivables as a method of financing also offers alternatives to management.
Investors and creditors can monitor a company's investment in receivables with the receivables
turnover ratio and the related average collection period. These ratios are calculated as follows:
Receivables turnover ratio
=
Net sales
Average accounts receivable (net)
Average collection period
=
365 days
Receivables turnover ratio
The receivables turnover ratio indicates the number of times during a period that the average
accounts receivable balance is collected. The average collection period is an approximation of the
number of days the average accounts receivable balance is outstanding.
APPENDIX 7A: CASH CONTROLS
Bank Reconciliation
Since all cash receipts are deposited into the bank account and cash disbursements are made by
check, the bank account provides a separate record of cash. Therefore, a comparison of the bank
account with the cash account, bank reconciliation, is an important procedure in the control of
cash. The first step in the reconciliation is to adjust the bank balance to the corrected cash balance
for deposits in transit, outstanding checks, and bank errors. Step 2 adjusts the book balance to the
corrected cash balance for timing differences involving transactions already reflected by the bank of
which the company is unaware (for example, service charges and NSF checks) and for company
errors. Each of the adjustments in step 2 requires a journal entry to correct the book balance.
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Step 1:
Bank Balance
+ Deposits outstanding
– Checks outstanding
+ Errors
Step 2:
Corrected balance
Book Balance
+ Collections by bank
– Service charges
– NSF checks
+ Errors
Corrected balance
Petty Cash
Petty cash funds are used to pay for low cost items such as postage, office supplies, delivery
charges, and entertainment expenses. A petty cash fund is established and then managed by the
petty cash custodian. The custodian disburses cash from the fund when the appropriate
documentation is presented (for example, a receipt for the purchase of office supplies). The
documentation is then used as a basis for replenishing the fund. For example:
To record the establishment of a $200 petty cash fund:
Petty cash ............................................................................................
Cash (checking account) ......................................................................
200
200
To record $170 in expenses and to replenish the fund:
Postage expense ...................................................................................
Delivery expense .................................................................................
Entertainment expense .........................................................................
Cash (checking account) ......................................................................
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APPENDIX 7-B: ACCOUNTING FOR IMPAIRMENT OF A RECEIVABLE
AND A TROUBLED DEBT RESTRUCTURING
If a receivable becomes impaired (worth less than before), it is remeasured. It is remeasured based
on the discounted present value of currently expected cash flows at the loan’s original effective rate
(regardless of the extent to which expected cash receipts have been reduced). One way impairment
can occur is when the terms of a debt agreement are changed as a result of financial difficulties
experienced by the debtor (borrower). This new arrangement is referred to as a troubled debt
restructuring.
If, instead, the receivable is settled outright at the time of the restructuring the creditor simply
records a loss for the difference between the carrying amount of the receivable and the fair value of
the asset(s) or equity securities received. But, if the receivable is continued, but with modified terms,
the difference between the receivable’s carrying amount and the discounted present value of the cash
flows after the restructuring is reported as a loss.
Accounting for impairments are handled similarly under U.S. GAAP and IFRS, but differ somewhat
in level of analysis and the specifics of impairment indicators. Both U.S. GAAP and IFRS allow
reversals of impairments under some circumstances.
SELF-STUDY QUESTIONS AND EXERCISES
Concept Review
1.
include such things as certain money market funds, treasury bills, and
commercial paper.
2.
A critical aspect of an internal control system is the
of duties. Employees involved
in
should not also have physical access to assets.
3.
Cash that is restricted in some way and not available for current use usually is reported as
or
.
4.
Accounts receivable initially are valued at the
and seller.
5.
price agreed upon by the buyer
reduce the amount to be paid if remittance is made within a specified
period of time.
6.
The
The
7.
Recognizing sales returns when they occur, could result in an
the period of the related sale.
8.
The
related sales revenue.
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method views cash discounts not taken as part of sales revenue.
method considers cash discounts not taken as interest revenue.
of income in
method attempts to estimate future bad debts and match them with the
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9.
Using the
percentage of each period's net credit sales.
approach, we estimate bad debt expense as a
10. Using the
approach to estimate future bad debts, we determine bad debt
expense by estimating the net realizable value of accounts receivable.
11. The write-off of an account receivable reduces both
and the
, thus having no effect on income and financial position.
12.
are formal credit arrangements between a creditor (lender) and a debtor
(borrower).
13. An
debt.
14. When
involves the pledging of specific accounts receivable as collateral for a
notes
15. The buyer
factored
receivable are transferred,
notes receivable.
assumes
the
risk of
.
the
uncollectibility
transaction
when
is
accounts
referred
to
as
receivable
are
16. The transfer of receivables with recourse is accounted for as a
if the transferor
surrenders control over the receivables transferred. Otherwise, the transfer is accounted for as
a
.
17. The first step in recording a discounting of a note is to
receivable prior to its being discounted.
on the note
18. The
ratio shows the number of times during a period that the
average accounts receivable balance is collected.
Questions 19 and 20 are based on Appendix 7-A.
19. Bank reconciliations include adjustments to the balance per
for timing differences
involving transactions already reflected in the company's accounting records that have not yet
been processed by the bank.
20. A
provides a more efficient way to pay for low cost items such as
postage, office supplies, and delivery charges.
Question 21 is based on Appendix 7-B.
21 In a troubled debt restructuring, if the receivable is
at the time of
the restructuring the creditor simply records a loss for the difference between the carrying
amount of the receivable and the fair value of the asset(s) or equity securities received.
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Answers:
1. Cash equivalents 2. separation, recordkeeping 3. investments and funds, other assets
4. exchange 5. Cash discounts 6. gross, net 7. overstatement 8. allowance 9. income statement
10. balance sheet 11. receivables, allowance for uncollectible accounts 12. Notes receivable
13. assignment 14. discounting 15. without recourse 16. sale, secured borrowing
17. accrue interest earned 18. receivables turnover 19. bank 20. petty cash fund
21. Settled outright
REVIEW EXERCISES
Exercise 1
Eastern Digital Corporation began 2013 with accounts receivable of $1,240,000 and a credit
balance in allowance for uncollectible accounts of $36,000. During 2013, credit sales totaled
$5,190,000 and cash collected from customers totaled $5,380,000. Also, actual write-offs of
accounts receivable in 2013 were $33,000. At end of the year, an accounts receivable aging
schedule indicated a required allowance of $32,300. No accounts receivable previously written off
were collected.
Required:
1. Determine the balance in accounts receivable at the end of 2013.
2. Prepare the entry to record the write-off of accounts receivable during the year and the year-end
adjusting entry to record bad debt expense.
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Solution:
Requirement 1
Beginning balance
Add: Credit sales
Less: Cash collections
Write-offs
Ending balance
$1,240,000
5,190,000
(5,380,000)
(33,000)
$1,017,000
Requirement 2
To record the write-off of accounts receivable:
Allowance for uncollectible accounts .......................................
Accounts receivable ..............................................................
33,000
33,000
To record bad debt expense:
Bad debt expense .......................................................................
Allowance for uncollectible accounts (determined below).............
Required allowance
Allowance account:
Beginning balance
Less: Write-offs
Balance before year-end adjusting entry
Year-end adjustment
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29,300
29,300
$32,300
$36,000
(33,000)
(3,000)
$29,300
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Exercise 2
Midwestern Electric obtained a $40,000 note from a customer on April 1, 2013. The note plus
interest at 9% is due on April 1, 2014. On July 31, 2013, Midwestern discounted the note at a local
bank. The bank's discount rate is 12%.
Required:
Prepare the journal entries required on July 31, 2013, to accrue interest and to record the
discounting for Midwestern. Assume that the discounting is accounted for as a sale.
Solution:
To accrue interest:
Interest receivable ......................................................................
Interest revenue ($40,000 x 9% x 4/12) ...........................................
1,200
1,200
To record the discounting:
Cash (proceeds determined below) ..........................................................
Loss on sale of note receivable (difference) ....................................
Note receivable (face amount) .....................................................
Interest receivable (determined above)...........................................
$40,000
3,600
43,600
(3,488)
$40,112
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40,112
1,088
40,000
1,200
Face amount
Interest to maturity ($40,000 x 9%)
Maturity value
Discount ($43,600 x 12% x 8/12)
Cash proceeds
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Exercise 3 (Based on Appendix 7)
You have been given the following information pertaining to the checking account of North Coast
Milling Company:
Bank statement:
Balance, March 1, 2013
Deposits
Checks processed
Collection of note by bank
Service charges recorded
NSF checks
Balance, March 31, 2013
$ 63,255
322,200
(344,500)
12,000
(80)
(200)
$ 52,675
General ledger cash account:
Balance, March 1, 2013
Deposits
Checks written
Balance, March 31, 2013
$ 61,250
330,200
(350,200)
$ 41,250
In addition, you determine that there were no deposits outstanding at the end of February and that
all outstanding checks at the end of February were processed by the bank in March.
Required:
Prepare a bank reconciliation for the month of March.
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Solution:
Step 1:
Bank Balance to Corrected Balance
Balance per bank statement
Add: Deposits outstanding ($330,200 - 322,200)
Deduct: Checks outstanding
Corrected cash balance
Step 2:
$52,675
8,000
(7,705) *
$52,970
Book Balance to Corrected Balance
Balance per books
Add: Note collected by bank
Deduct:
Service charges
NSF checks
Corrected cash balance
*Checks written in March
Checks processed by the bank in March
Less outstanding checks at the end of February ($63,255 - 61,250)
March checks processed in March
Checks still outstanding
$41,250
12,000
(80)
(200)
$52,970
$350,200
$344,500
(2,005)
(342,495)
$ 7,705
MULTIPLE CHOICE
Enter the letter corresponding to the response that best completes each of the following statements
or questions.
1. Which of the following might be classified as a cash equivalent?
a. Cash in a checking account.
b. 30-day treasury bill.
c. Money orders waiting to be deposited.
d. 120-day treasury bill.
2. An internal control system is designed to do all but which of the following?
a. Promote operational efficiency.
b. Safeguard assets.
c. Encourage adherence to company policies.
d. Assure the promotion of the most qualified employees.
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3. Which of the following is true about cash reporting under IFRS?
a. Cash accounts are typically viewed as investments, with overdrafts treated as
unrealized losses.
b. Overdrafts in one cash account can typically be offset against positive balance in
other cash accounts.
c. Overdrafts are typically treated as current liabilities, regardless of the existence of
other cash accounts. .
d. Cash accounts are typically viewed as immaterial.
4. A company uses the gross method to account for cash discounts offered to its customers.
If payment is made before the discount period expires, which of the following is correct?
a. Sales discounts is debited for the amount of discounts taken by customers.
b. Sales discounts is credited for the amount of discounts taken by customers.
c. Interest expense is debited for the amount of discounts taken by customers.
d. Accounts receivable is credited for the amount of discounts taken by customers.
5. Allister Company does not use the allowance method to account for bad debts and
instead any bad debts that do arise are written off as bad debt expense. What problem
might this create if bad debts are material?
a. Receivables likely will be understated.
b. No problems are created.
c. Receivables likely will be overstated.
d. The matching principle is violated when the write-off occurs in the same period that
the receivable is initially recorded.
6. Jasper Company uses the allowance method to account for bad debts. During 2013, the
company recorded bad debt expense of $9,000 and wrote off as uncollectible accounts
receivable totaling $5,000. These transactions caused a decrease in working capital
(current assets minus current liabilities) of:
a. $ 7,000
b. $ 5,000
c. $ 9,000
d. $14,000
7.
The Reingold Hat Company uses the allowance method to account for bad debts. During
2013, the company recorded $800,000 in credit sales. At the end of 2013, account
balances were: Accounts receivable, $120,000; Allowance for uncollectible accounts,
$3,000 (credit). If bad debt expense is estimated to be 3% of credit sales, the appropriate
adjusting entry will include a debit to bad debt expense of:
a. Zero.
b. $27,000
c. $21,000
d. $24,000
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8.
Enchill Company accrues bad debt expense during the year at an amount equal to 3% of
credit sales. At the end of the year, a journal entry adjusts the allowance for
uncollectible accounts to a desired amount based on an aging of accounts receivable. At
the beginning of 2013, the allowance account had a credit balance of $18,000. During
2013, credit sales totaled $480,000 and receivables of $14,000 were written off. The
year-end aging indicated that a $21,000 allowance for uncollectible accounts was
required. Enchill's bad debt expense for 2013 would be:
a. $17,000
b. $ 2,600
c. $21,000
d. $14,400
9.
Harmon Sporting Goods received a $60,000, 6-month, 10% note from a customer. Four
months after receiving the note, it was discounted at a local bank at a 12% discount rate.
The cash proceeds received by Harmon were:
a. $63,000
b. $64,680
c. $61,740
d. $67,200
10. At the end of June, the Marquess Company factored $200,000 in accounts receivable
with Homemark Finance. The transfer is made without recourse. Homemark charges a
fee of 3% of receivables factored. During July, $150,000 of the factored receivables are
collected. What amount of loss on sale of receivables would Marquess record in June?
a. $6,000
b. $4,500
c. $1,500
d. Zero.
11. In question 9, if the transfer were made with recourse but is still accounted for as a sale,
what amount of loss on sale of receivables would the company record in June assuming
the estimated recourse liability is $2,000?
a. $6,500
b. $8,000
c. $4,000
d. Zero.
12. Which of the following is true regarding accounting for transfers of receivables under
IFRS?
a. Transfers of receivables can never be treated as a sale of receivables
b. Transfers of receivables can never be treated as a secured borrowing
c. Whether the risks and rewards of ownership have been transferred is sometimes the
key factor for determining how to account for a transfer of receivables.
d. none of the above are true.
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13. The following data are available for the Hunting Balloon Company:
Sales for the current year
Cost of goods sold for the current year
Accounts receivable, beginning of year
Accounts receivable, end of year
$1,500,000
1,200,000
140,000
160,000
The accounts receivable turnover ratio for the current year is:
a. 8.00
b. 10.71
c. 10.00
d. 9.375
Questions 14 through 17 are based on Appendix 7-A.
14. The replenishment of a petty cash fund might include which of the following?
a. A debit to cash.
b. A debit to petty cash.
c. A debit to office supplies expense.
d. A credit to petty cash.
15. In a bank reconciliation, deposits outstanding are:
a. Subtracted from the bank balance.
b. Added to the book balance.
c. Added to the bank balance.
d. Subtracted from the book balance.
16. In a bank reconciliation, NSF checks are:
a. Subtracted from the bank balance.
b. Added to the book balance.
c. Added to the bank balance.
d. Subtracted from the book balance.
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17. Alvin Electronics is in the process of reconciling its bank account for the month of
November. The following information is available:
Balance per bank statement
Outstanding checks
Deposits outstanding
Bank service charges for November
Check written by Alvin for $300 but recorded incorrectly by
Alvin as a $30 disbursement.
$8,325
2,400
1,215
35
What should be the corrected cash balance at the end of November?
a. $6,870
b. $7,140
c. $6,835
d. $7,105
Question 18 is based on Appendix 7-B.
18. Which of the following is NOT true about accounting for a troubled debt restructuring?
a. If a receivable becomes impaired, it is remeasured at the discounted present value
of currently expected cash flows.
b. If a receivable is remeasured, the discount rate is based on the loan’s original
effective rate.
c. If a receivable is continued, but with modified terms, no loss is typically recorded.
d. Sometimes receivables are settled outright at the time of a restructuring.
Answers:
1. b.
2. d.
3. b.
4. a.
5. c.
6. c.
7.
8.
9.
10.
11.
12.
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d.
a.
c.
a.
b.
c
13.
14.
15.
16.
17.
18.
c.
c.
c.
d.
b.
c.
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CPA Exam Questions
1. a. Allowance for uncollectible accounts, beginning balance
Add: Bad debt expense (2% x $9,000,000)
Less: Write-offs
Allowance for uncollectible accounts, ending balance
2. a. Accounts receivable, beginning balance
Add: Credit sales
Less: Write-offs
Less: Accounts receivable, ending balance
Cash collections
$260,000
180,000
(325,000)
$115,000
$ 600
3,200
(200)
(500)
$3,100
3. c. The reinstatement of a previously written off account increases the
allowance account. The collection of the reinstated account does not
affect the allowance account. The net effect of the reinstatement and
collection is an increase in the allowance account. Neither the
reinstatement nor the subsequent collection of the account has any
effect on the expense.
4. b. Accounts receivable, beginning balance
Add: Credit sales
Less: Sales returns
Less: Write-offs
Less: Cash collections (
Accounts receivable, ending balance
$ 650,000
2,700,000
(75,000)
(40,000)
(2,150,000)
$1,085,000
5. c. The key phrase is "without recourse" which means that Gar Co. has
transferred the collection risk to Ross Bank. Ross does not have any
recourse against Gar Co. if the accounts are not collected. Thus, Gar
has sold the accounts receivable to Ross Bank and has also transferred the risk
associated with collection.
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6. a. The aging method is a balance sheet approach that calculates the required
ending balance in the allowance for uncollectible accounts. The
calculation is as follows:
Estimated % Uncollectible x Amount=Required Balance
1% x $120,000 =
$1,200
2% x $ 90,000 =
1,800
6% x $100,000 =
6,000
Total required balance
$9,000
7. a. The estimate using the income statement approach is:
$1,750,000 x 2% = $35,000
The estimate using the balance sheet approach is:
Required ending balance ($900,000 x 5%) $45,000
Less: Allowance for uncollectible accounts
before recording bad debt expense
(16,000)
Bad debt expense
$29,000
8. b. IFRS allows overdrafts to be offset with positive cash balances if the
overdrafts are payable on demand and which fluctuate as part of its cash
management program.
9. c. IAS No. 39 allows receivables to be accounted for as “available for sale”
investments if that approach is elected upon initial recognition of the
receivable.
10. d. Under IFRS, measurement of an impairment of a receivable is required if there
is objective evidence that a loss event has occurred that has an impact on the future
cash flows to be collected and that can be estimated reliably.
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CMA Exam Questions
1. c. The allowance method records bad debt expense systematically as a
percentage of either credit sales or the level of accounts receivable.
The latter calculation considers the amount already existing in the
allowance account. The credit is to a contra asset or allowance
account. As accounts receivable are written off, they are charged to
the allowance account.
2. d. If a company uses the allowance method, the write-off of a receivable
has no effect on total assets. The journal entry involves a debit to the
allowance account and a credit to accounts receivable. The net effect
is that the asset section is both debited and credited for the same
amount. Thus, there will be no effect on either total assets or net
income.
3. c. The entry is to debit bad debt expense and credit the allowance
account. Net credit sales were $1,500,000 ($1,800,000 – $125,000 of
discounts – $175,000 of returns). Thus, the expected bad debt
expense is $22,500 (1.5% x $1,500,000). This amount is recorded
regardless of the balance remaining in the allowance account from
previous periods. The net effect is that the allowance account is increased by $22,500.
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