Cash and
Receivables
Chapter 7
Learning Objectives
1. Define internal control and describe some key elements of an internal
control system for cash receipts and disbursements. SELF-STUDY
2. Explain the possible restrictions on cash and their implications for
classification on the balance sheet.
3. Distinguish between the gross and net method of accounting for cash
discounts.
4. Describe the accounting treatment for merchandise returns.
5. Describe the accounting treatment of anticipated uncollectible
accounts receivable.
6. Describe the two approaches to estimating bad debts.
7. Describe the accounting treatment of short-term notes receivable.
8. Differentiate between the use of receivables in financing arrangements
accounted for as a secured borrowing and those as a sale.
9. Describe the variables that influence a company’s investment in
receivables and calculate the key ratios.
10. Discuss the primary differences between U.S. GAAP and IFRS with
respect to cash and receivables.
Cash and Cash Equivalents
Cash
Currency
and coins
Balances in
checking
accounts
Items for deposit such as
checks and money orders
from customers
Cash equivalents are short-term, highly liquid
investments that can be readily converted to cash.
Money market
funds
Treasury bills
Commercial
paper
Cash and Cash Equivalents
Cash
Currency, coins and amounts on deposit in bank
accounts: checking accounts, and many savings
accounts. Also includes items such as customer checks,
cashier checks, certified checks, and money orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. That have an original maturity date of three
months or less from the date of purchase
3. US Treasury Bills & Notes: 3-month maturity.
4. 3-month CDs and Money Market Funds
6-4
Cash & Cash Equivalents
On Dec. 31, 2010, ABC Co's total CASH COUNT= $1,000,000
The following items are included in the CASH COUNT:
 Petty cash funds=$12,000,
 Customers Checks =$3,000,
 Coins =$1,000 and
 Stamps =$100.
The following items are not included in cash count:
 -Three-month CD: $10,000
 -Two-month Treasury Note (Bill): $7,000
Required:
Prepare the Current Assets Section of the Balance Sheet
Restricted Cash and
Compensating Balances
Restricted Cash
Management’s intent to use a certain amount
of cash for a specific purpose – future plant
expansion, future payment of debt.
Compensating Balance
Minimum balance that must be
maintained in a company’s bank
account as support for funds
borrowed from the bank.
Cash & Cash Equivalents, Restricted
Cash and Compensating Balances
Exercise 7–1
Cash & Cash Equivalents, Restricted
Cash and Compensating Balances
Exercise 7–1:
Requirement 1
a.
b.
c.
f.
Balance in checking account
Balance in savings account
Un-deposited customer checks
Currency and coins on hand
U.S. treasury bills with 2-month maturity
Total
$13,500
22,100
5,200
580
15,000
$56,380
Requirement 2
d. The $400,000 savings account will be used for future plant expansion and therefore
should be classified as a noncurrent asset, either in investments & Funds.
e. The $20,000 in the checking account is a compensating balance for a long-term loan
and should be classified as a noncurrent asset, either in investments & Funds.
f. The $20,000 in 7-month treasury bills should be classified as a current asset along
with other temporary investments.
Cash & Cash Equivalents, Restricted
Cash and Compensating Balances
RED WING CORPORATION
Partial Balance Sheet
As of December 31, 2013
Current Assets:
Cash and cash equivalents
Marketable Securities
$56,380
20,000
Investments and Funds:
Plant Expansion Fund
Loan Compensating Fund
400,000
20,000
U.S. GAAP vs. IFRS
In general, cash and cash equivalents are
treated similarly under IFRS and U.S. GAAP. One difference
is highlighted below.

Bank overdrafts are treated
as liabilities.

Bank overdrafts may be
offset against other cash
accounts.
Exercise 4
Internal Control (SELF-STUDY)
Encourages adherence to
company policies
and procedures
Promotes operational
efficiency
Minimizes errors
and theft
Enhances the reliability and
accuracy of accounting data
Internal Control Procedures (SELF-STUDY)
Cash Receipts
 Separate responsibilities for receiving cash, recording cash
transactions, and reconciling cash balances.
 Match the amount of cash received with the amount of cash
deposited.
 Close supervision of cash-handling and cash-recording
activities.
Cash Disbursements

All disbursements, except petty cash, made by check.

Separate responsibilities for cash disbursement documents,
check authorization, check signing, and record keeping.

Checks should be signed only by authorized individuals.
Internal Control Procedures
PETTY CASH ACCOUNTING
BANK RECONCILIATION
Appendix 7-A: Cash Controls
Petty cash is
used for
minor
expenditures.
Petty cash
fund
Has one
custodian.
Replenished
periodically.
P2
Petty Cash System of Control
Small payments required in most companies for
items such as postage, courier fees, repairs and
supplies.
Internal Control requires that companies pay
for these small amounts from Petty Cash
Fund.
6-15
P2
Operating a Petty Cash Fund
Petty Cash
Company
Cashier
Petty
Cashier
May 1
Petty cash
Cash
400
400
Accountant
6-16
P2
Operating a Petty Cash Fund
Petty
Cashier
Petty Cash
6-17
P2
Operating a Petty Cash Fund
A petty cash
fund is used only
for business
expenses.
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-18
P2
Operating a Petty Cash Fund
Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.
Receipts
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-19
P2
Operating a Petty Cash Fund
Receipts
$125
Company
Cashier
To reimburse
petty cash fund
May 31
Use a Cash
Over and Short
account if needed.
Petty
Cashier
Postage expense
Delivery expense
Cash
45
80
125
Accountant
6-20
Operating a Petty Cash Fund
Sometimes, the petty cash receipts plus
the cash remaining will not total to the
fund balance.
i. A shortage is recorded as an expense in the
reimbursing entry with a debit to the Cash
Over and Short account.
ii. An overage is recorded with a credit to the
Cash Over and Short account in the
reimbursing entry.
P2
Petty Cash Example
Tension Co. maintains a petty cash fund of $400. The
following summary information was taken from petty
cash vouchers for July:
Travel Expenses
Customer Business Lunches
Express Mail Postage
Miscellaneous Office Supplies
$79.30
93.42
55.00
32.48
$260.20
Let’s look at replenishing the fund if the
Cash Balance on July 31 was $137.80.
6-22
Petty Cash Example
P2
What amount of cash will be required to replenish
the petty cash fund?
a.
b.
c.
d.
$260.20
$262.20
$139.80
$137.80
6-23
Petty Cash Example
P2
What amount of cash will be
required to replenish the petty
cash fund?
a.
b.
c.
d.
$260.20
$262.20
$139.80
$137.80
Desired Balance
Actual Balance
Amount Needed
$ 400.00
137.80
$ 262.20
Let’s prepare the journal entry to replenish the petty cash fund.
6-24
P2
Petty Cash Example
Journal entry to replenish petty cash fund
Dr.
July 31 Travel Expense
79.30
Entertainment Expense
93.42
Postage Expense
55.00
Office Supplies Expense
32.48
Cash Over and Short
Cash
Cr.
2.00
262.20
6-25
EXERCISE 26, 27
Appendix 7-A: Cash Controls
A bank reconciliation explains the difference between cash reported
on bank statement and cash balance on a company’s books.
Provides information for reconciling journal entries.
Bank Balance
Book Balance
+ Deposits in Transit
+ Bank Collections
- Outstanding Checks
- Service Charges
- NSF Checks
± Bank Errors
= Corrected Balance
± Book Errors
= Corrected Balance
Bank Statement
Once a month, the bank sends each depositor
a bank statement showing activities of a bank
account.
A bank statement includes, at least, the
following:
1.
2.
3.
4.
Beginning cash balance per bank;
Check & other debits decreasing the balance;
Deposits & other credits increasing the
balance;
Ending cash balance per bank.
Bank Statement
First National Bank
Nashville, TN 37459
May 31, 2009
Clothes Mart
Nashville, TN
Acct No 278609
Previous
Balance
Total Checks
Total
Deposits
1488.79
5/1
5/2
5/4
5/7
1,367.09
107
2,604.22
55.00
108
109
279.50
44.75
5/9
5/12
5/15
5/18
110
111
21.81
37.55
112
175.98
5/21
5/27
5/30
5/31
113
114
288.31
12.54
Current
Balance
2,725.92
1,251.88
825.04
527.30
115
451.65
Bank Reconciliation
P3
A bank reconciliation is prepared periodically to explain
the difference between cash reported on the bank
statement and the cash balance on company’s books.
Bank Statement
First National Bank
Nashville, TN 37459
May 31, 2009
*
Clothes Mart
Nashville, TN
Why are the
balances different?
Acct No 278609
Previous
Balance
Total Checks
Total
Deposits
1488.79
5/1
5/2
5/4
5/7
1,367.09
107
2,604.22
55.00
108
109
279.50
44.75
5/9
5/12
5/15
5/18
110
111
21.81
37.55
112
175.98
5/21
5/27
5/30
5/31
113
114
288.31
12.54
115
451.65
Current
Balance
2,725.92
Account: Cash
GENERAL LEDGER
Acct. No.
1,251.88
Date
Item
May 31 Balance
PR
Debit
Credit
102
Balance
DR (CR)
2,481.18
825.04
527.30
6-30
Reconciling Items
Bank Statement Balance
 Add:
Deposits in transit.
 Deduct: Outstanding
Checks
 Add or Deduct: Bank
errors.
Adjusted Bank Balance
Book Balance
• Add: Collections made by the
bank.
• Add: Interest earned on
checking account. =>CM
• Deduct: Nonsufficient funds
check (NSF).
• Deduct: Bank service
charge =>DM
• Add or Deduct:
Book errors
Adjusted Book Balance.
6-31
Reconciling Items
Identify and list any unrecorded Debit
Memoranda (DM) from the bank for NSF
Checks, service charges, and errors overstating the book balance.
=> Deduct them from the book balance.
Identify and list any unrecorded Credit
Memoranda (CM) from the bank for interest,
collections, and errors understating the book
balance.
=> Add them to the book balance.
Bank Reconciliation
P3
Two sections:
1.
2.
Reconcile bank statement balance to the adjusted bank
balance.
Reconcile book balance to the
adjusted book balance.
The adjusted balances should be equal.
6-33
Bank Reconciliation Example
P3
Let’s prepare a July 31 bank reconciliation
statement for the Simmons Company.


The July 31 bank statement indicated a balance
of $9,610.
The cash general ledger account on that date
shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next screen.
6-34
Bank Reconciliation Example
1.
Outstanding checks totaled $2,417.
2.
A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
3.
The bank returned a customer’s NSF check for $225
received as payment on account receivable.
4.
The bank statement showed $30 interest earned
during July.
5.
Check No. 781 for supplies expense cleared the bank
for $268 but was erroneously recorded in our books as
$240.
6.
A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
6-35
P3
Bank Reconciliation Example
Simmons Company
Bank Reconciliation
July 31, 2009
Bank Balance, July 31
Add: Deposit in Transit
Less: Bank Error
$
486
Outstanding Checks
2,417
Adjusted Balance, July 31
Book Balance, July 31
Add: Interest
Less: Recording Error
NSF Check
Adjusted Balance, July 31
$
(2,903)
$ 7,207
$
$
9,610
500
28
225
$
7,430
30
(253)
7,207
6-36
P3
Recording Adjusting Entries
from a Bank Reconciliation
Only amounts shown on the book portion of the
reconciliation require an adjusting entry.
Dr.
30
July 31 Cash
Interest revenue
July 31 Supplies expense
Accounts receivable
Cash
Cr.
30
28
225
253
6-37
P3
Recording Adjusting Entries from
a Bank Reconciliation
After posting the reconciling entries the cash account
looks like this:
Account: Cash
GENERAL LEDGER
Acct. No.
Date
Item
July 31 Balance
31 Adjusting entry
31 Adjusting entry
PR
Debit
Credit
30
253
101
Balance
DR (CR)
7,430
7,460
7,207
Adjusted balance on July 31.
6-38
Exercises 28, 29
Accounts Receivable
Result from the credit
sales of goods or
services to customers.
Are classified as
current assets.
Are recorded net of
trade discounts.
P1
Trade Discounts
Used by manufacturers and wholesalers to
offer better prices for greater quantities
purchased.
Example
Matrix, Inc. offers a 30% trade
discount on orders of 1,000
units or more of their popular
product Racer. Each
Racer has a list price of $5.25.
Quantity sold
Price per unit
Total
Less 30% discount
Invoice price
1,000
$ 5.25
5,250
(1,575)
$ 3,675
4-41
Cash (Sales) Discounts
increase sales
Cash discounts
encourage early
payment
increase likelihood of
collections
P1
Cash (Sales) Discounts
A deduction from the invoice price granted to
induce early payment of the amount due.
Terms
Discount Period
Credit
Period
Time
Due
Date of
Invoice
Due: Invoice
price minus
discount
Due: Full Invoice Price
4-43
Cash (Sales) Discounts
2/10,n/30
Discount
percent
Number of
days
discount is
available
Otherwise,
net (or all)
is due
Credit
period
When Discount is Not
Taken
P1
If we fail to take a 2/10, n/30 discount,
is it really expensive?
365 days ÷ 20 days × 2% = 36.5% annual rate
Days
in a
year
Number
of additional
days before
payment
Percent
paid to
keep
money
4-45
Cash (Sales) Discounts
Gross
Method
Net
Method
Sales are recorded
at the invoice
amounts.
Sales discounts
are recorded as reduction of
revenue if payment is received
within the discount period.
Cash (Sales) Discounts
On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10,
n/30. On October 14, the customer sent a check for $13,720 taking
advantage of the discount to settle $14,000 of the amount. On November
4, the customer paid the remaining $6,000.
Cash (Sales) Discounts
Exercise 5 (1 & 2)
and
Exercise 6
Sales Returns
Merchandise
may be
returned by a
customer to
a supplier.
A special price
reduction, called
an allowance,
may be given as
an incentive to
keep the
merchandise.
To avoid misstating the financial statements,
sales revenue and accounts receivable should
be reduced by the amount of returns in the
period of sale if the amount of returns is
anticipated to be material.
P2
Accounting for Merchandise
Sales
Matrix, Inc.
Partial Income Statement
For Year Ended May 31, 2009
Sales
Less:
Sales discounts
Sales returns and allowances
Net sales
Cost of goods sold
Gross profit
$ 2,451,000
$ 29,412
18,500
47,912
$ 2,403,088
(1,928,600)
$
474,488
Sales discounts and returns and allowances are Contra Revenue accounts.
4-50
Sales Returns
During the first year of operations, Hawthorne sold $2,000,000 of
merchandise that had cost them $1,200,000 (60%).
Industry experience indicates a10% return rate.
During the year $130,000 was returned prior to customer payment.
Record all necessary Journal Entries including YE adjustment.
Accounts Receivable
2,000,000
Sales
Cost of Goods Sold
1,200,000
Inventory
Actual Returns
Sales returns (I/S Account)
130,000
Accounts receivable
Inventory
78,000
Cost of goods sold (60%)
Adjusting Entries
Sales returns (200,000 – 130,000)
70,000
Allowance for sales returns (B/S Account)
Inventory estimated returns
42,000
Cost of goods sold (60%)
2,000,000
1,200,000
130,000
78,000
70,000
42,000
Sales Returns
Exercise 8
Uncollectible Accounts Receivable
Bad debts result from credit customers
who are unable to pay the amount they owe,
regardless of continuing collection efforts.
In conformity with the matching
principle, bad debt expense should
be recorded in the same
accounting period in which the
sales related to the uncollectible
account were recorded.
Uncollectible Accounts Receivable
Most businesses record an estimate of the bad
debt expense by an adjusting entry at the
end of the accounting period.
Normally classified as
a selling expense and
closed at year-end.
Contra asset account to
accounts receivable.
Bad debt expense
Allowance for uncollectible accounts
xxx
xxx
Allowance for Uncollectible Accounts
Accounts Receivable
Less: Allowance for Uncollectible Accounts
Net Realizable Value
Net realizable value is the amount of the accounts
receivable that the business expects to collect.


Income Statement Approach
Balance Sheet Approach


Composite Rate
Aging of Receivables
Allowance Method
of estimating
Bad Debts Expenses
Two Methods
1. Percent of Sales Method (Income Statement)
2. Accounts Receivable Methods (Balance Sheet)
 Percent of Accounts Receivable Method
 Aging of Accounts Receivable Method
7-56
Percent of Sales Method
Bad debts expense is computed as follows:
Current Period Sales
X Bad Debt %
= Estimated Bad Debts Expense
Barton has credit sales of $1,400,000 in 2009.
Management estimates 0.5% of credit sales will
eventually prove uncollectible.
What is Barton’s Bad Debts Expense for 2009?
7-57
P2
Percent of Sales Method
$
×
= $
1,400,000
0.50%
7,000
Barton’s accountant
computes estimated
Bad Debts Expense of
$7,000.
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
DR
7,000
CR
7,000
To record estimated bad debts
7-58
Percent of Sales Method
Barton has $100,000 in accounts receivable and a $900 credit
balance in Allowance for Doubtful Accounts on Dec.31, 2009.
What is the balance in AFDA on Dec. 31, 2009?
Prepare the ‘T’ accounts for A/R and AFDA showing the
balances as of 12/31/09.
Bal.
Accounts Receivable
100,000
Allowance for Doubtful Accounts
Dec. 31
900
BDE
7,000
Dec. 31
7,900
Barton, Co.
Partial Balance Sheet
December 31, 2009
DR
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 100,000
7,900
CR
$
92,100
Percent of Sales Method
(Income Statement Approach)
Exercise 10
Percent of Accounts Receivable
Method
 Compute
the estimate of the Allowance
for Doubtful Accounts:
Year-end Accounts Receivable
 Bad
× Bad Debt %
Debts Expense is computed as:
Estimated Adj. Bal. in Allowance for Doubtful Accounts
Unadj. Year-End Bal. in Allowance for Doubtful Accounts
= Estimated Bad Debts Expense
7-61
Percent of Accounts
Receivable
Barton has $100,000 in accounts receivable and a
$900 credit balance in Allowance for Doubtful
Accounts on December 31, 2009.
Past experience suggests that 4% of receivables
are uncollectible.
What is the balance in AFDA on Dec. 31, 2009?
What is Barton’s Bad Debts Expense for 2009?
7-62
Percent of Accounts
Receivable
Desired balance in Allowance for
Doubtful Accounts.
$ 100,000
×
4.00%
= $
4,000
Allowance for
Doubtful Accounts
900
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
3,100
4,000
DR
3,100
CR
3,100
To record estimated bad debts
7-63
Percent of Accounts Receivable
Bal.
Accounts Receivable
100,000
Allowance for Doubtful Accounts
Dec. 31
900
BDE
3,100
Dec. 31
4,000
Barton, Co.
Partial Balance Sheet
December 31, 2009
DR
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 100,000
4,000
CR
$
96,000
Percent of Accounts Receivable
Exercise 11, 12, 13
Aging of Accounts Receivable
Method
 Each receivable is grouped by
how long it is past its due date.
 Each age group is multiplied
by its estimated bad debts
percentage.
 Estimated bad debts for each
group are totaled.
7-66
P2
Aging of Accounts Receivable
Barton, Co.
Schedule of Accounts Receivable by Age
December 31, 2009
Accounts
Estimated
Receivable
Percent
Uncollectible
Days Past Due
Balance
Uncollectible
Amount


Not Yet Due
1 - 30 Days Past Due
31 - 60 Days Past Due
61 - 90 Days Past Due
Over 90 Days Past Due

$
64,500
18,500
10,000
3,900
3,100
$ 100,000
1% $
3%
7%
40%
60%
$
645
555
700
1,560
1,860
5,320
7-67
P2
Aging of Accounts
Receivable
Barton’s unadjusted balance
in the allowance account is
$900.
Allowance for
Doubtful Accounts
900
4,420
5,320
We estimated the proper
balance to be $5,320.
DR
Dec. 31 Bad Debts Expense
4,420
Allowance for Doubtful Accounts
CR
4,420
To record estimated bad debts
7-68
Percent of Accounts Receivable
Method (AGING of A/R)
Problem 1, 4(c)
Writing Off a Bad Debt
under the Allowance Method
With the allowance method, when an account
is determined to be uncollectible, the debit
goes to Allowance for Doubtful Accounts.
Barton determines that Martin’s $300
account is uncollectible.
Dec. 31 Allowance for Doubtful Accounts
Accounts Receivable - Martin
DR
300
CR
300
To write-off an uncollectible account
7-70
P2
Recovery of a Bad Debt
Subsequent collections on accounts written
off require that the original write-off entry be
reversed before the cash collection is
recorded.
Feb. 8
Accounts Receivable - Martin
Allowance for Doubtful Accounts
DR
300
CR
300
To reinstate account previously written off
Feb. 8
Cash
300
Accounts Receivable - Martin
300
To record full payment on account
7-71
Summary of Measurement and Reporting
Issues for Accounts Receivable
Recognition
Depends on the earnings process; for most credit sales,
revenue and the related receivables are recognized at the
point of delivery.
Initial valuation
Initially recorded at the exchange price agreed upon by the
buyer and seller.
Subsequent valuation
Initial valuation reduced to net realizable value by:
1. Allowance for sales returns
2. Allowance for uncollectible accounts:
The income statement approach
 The balance sheet approach
Classification
Almost always classified as a current asset.
Notes Receivable
A written promise to pay a specific
amount at a specific future date.
Face
amount
of the
note
×
Annual
interest
rate
Even for
maturities less
than 1 year, the
rate is
annualized.
×
Fraction of
the annual =
period
Interest
Interest-Bearing Notes
On November 1, 2014, West, Inc., loans $25,000 to Winn Co. The
note bears interest at 12% and is due on November 1, 2015.
Prepare the journal entry on November 1, 2014, December 31,
2014, (year-end) and November 1, 2015, for West.
November 1, 2014
Notes receivable
Cash
December 31, 2014
Interest receivable
Interest revenue
November 1, 2015
Cash
Note receivable
Interest receivable
Interest revenue
25,000
25,000
500
500
28,000
25,000
500
2,500
Interest-Bearing Notes
Exercise 14
Noninterest-Bearing Notes

Actually do bear interest.

Interest is deducted
(discounted) from the face
value of the note.

Cash proceeds or Sales Value
equal face value of note less
discount.
Noninterest-Bearing Notes
On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterest
bearing note from Winn Co. as payment for a sale. The
note is discounted at 12% and is due on Dec. 31,2014.
Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014.
January 1, 2014
Notes receivable
Discount on notes receivable
Sales revenue (Cash)
25,000
*3,000
22,000
*($25,000 * 12% = $3,000)
December 31, 2014
Cash
Discount on notes receivable
Interest revenue
Note receivable
25,000
3,000
***Effective Interest Rate = (3,000 / 22,000) = 13.64%
3,000
25,000
Noninterest-Bearing Notes
Exercise 15
U.S. GAAP vs. IFRS
In general, IFRS and U.S. GAAP are very similar with respect
to accounts receivable and notes receivable. Differences are
highlighted below.

U.S. GAAP allows a “fair value
option” for accounting for
receivables.

U.S. GAAP does not allow
receivables to be accounted for as
“available for sale” investments.

U.S. GAAP requires more
disaggregation of accounts and
notes receivable in the balance
sheet or notes.

IFRS restricts the circumstances in
which a “fair value option” for
accounting for receivables is
allowed.

Until 2015, companies may account
for receivables as “available for sale”
investments if the approach is
elected initially. After January 1,
2015, this treatment is no longer
allowed.
Financing with Receivables (Not Covered)
Companies may use their
receivables to obtain
immediate cash.
Factoring Arrangements
2. Accounts Receivable
SUPPLIER
(Transferor)
RETAILER
1. Merchandise
FACTOR
(Transferee)
A factor is a financial institution that buys receivables
for cash, handles the billing and collection of the
receivables, and charges a fee for the service.
Secured Borrowing
On December 1, 2013, the Santa Teresa Glass Company borrowed $500,000 from Finance
Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned
$620,000 of its receivables as collateral for the loan. Finance Bank charges a finance fee equal
to 1.5% of the accounts receivable assigned.
Cash (difference)
Finance charge expense (1.5% * $620,000)
Liability – financing arrangement
490,700
9,300
500,000
Santa Teresa Glass will continue to collect the receivables, and will record any discounts, sales
returns, and bad debt write-offs, but will remit the cash to Finance Bank, usually on a monthly
basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa
Glass records the following entries.
Cash
400,000
Accounts receivable
400,000
Interest expense ($500,000 * 12% * 1/12)
Liability – financing arrangement
Cash
5,000
400,000
405,000
Sale of Receivables
Treat as a sale if all of these conditions are met:
 receivables are isolated from transferor.
 transferee has right to pledge or exchange receivables.
 transferor does not have control over the receivables.


Transferor cannot repurchase
receivable before maturity.
Transferor cannot require return
of specific receivables.
Sale of Receivables
Without recourse




An ordinary sale of receivables to the factor.
Factor assumes all risk of uncollectibility.
Control of receivable passes to the factor.
Receivables are removed from the books, fair value of cash and
other assets received is recorded, and a financing expense or
loss is recognized.
With recourse


Transferor (seller) retains risk of uncollectibility.
If the transaction fails to meet the three conditions
necessary to be classified as a sale, it will be treated as
a secured borrowing.
Sale of Receivables
In December 2013, the Santa Teresa Glass Company factored accounts receivable that
had a book value of $600,000 to Factor Bank. The transfer was made without recourse.
Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor,
and Factor immediately remits to Santa Teresa cash equal to 90% of the factored
amount (90% × $600,000 = $540,000). Factor retains the remaining 10% (estimated to
have a fair value of $50,000) to cover its factoring fee (equal to 4% of the total factored
amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales
returns and allowances.
Assume the same facts as above, except that Santa Teresa Glass sold the receivables
to Factor with recourse and estimates the fair value of the recourse obligation to be
$5,000.
Sale of Receivables
Securitization: Transfer receivables to a SPE
Special Purpose Entity (SPE)
Qualifying Special Purpose Entity (QSPE)
New rules eliminate QSPE and require consolidation!
Participating Interests: Transfer portion of a receivable
Example: transfer right to interest, but retain right to
principal
New rules require a partial transfer be treated as a
secured borrowing, unless specific conditions are
met!
Transfers of Notes Receivable
On December 31, Stridewell accepted a nine-month 10 percent
note for $200,000 from a customer. Three months later on
March 31, Stridewell discounted the note at its local bank. The
bank’s discount rate is 12 percent.
Before preparing the journal entry to record the
discounting, Stridewell must record the accrued interest on
the note from December 31 until March 31.
Interest receivable
Interest revenue
$200,000 × 10% × 3/12
5,000
5,000
Transfers of Notes Receivable
Face amount of note receivable
Interest to maturity ($200,000 × 10% × 9/12)
Maturity value of note receivable
Discount fee ($215,000 × 12% × 6/12)
Cash proceeds
Cash
Loss on sale of note receivable
Notes receivable
Interest receivable
$
$
200,000
15,000
215,000
(12,900)
202,100
202,100
2,900
$205,000  $202,100
200,000
5,000
Deciding Whether to Account for a Transfer
as a Sale or a Secured Borrowing
U.S. GAAP vs. IFRS
The U.S. GAAP and the IFRS approaches often
lead to similar accounting treatment for transfers
of receivables.

U.S. GAAP focuses on whether
control of assets has shifted from
the transferor to the transferee.

IFRS requires a more complex
decision process. The company has
to have transferred the rights to
receive the cash flows from the
receivable, and then considers
whether the company has
transferred “substantially all of the
risks and rewards of ownership,” as
well as whether the company has
transferred control.
Receivables Management
Receivables
Turnover =
Ratio
Net Sales
Average Accounts Receivable
This ratio measures how many
times a company converts its
receivables into cash each year.
Average
Collection
Period
365
=
Receivables Turnover Ratio
This ratio is an approximation of the
number of days the average accounts
receivable balance is outstanding.
Receivables Management
Symantec Corp. vs. CA, Inc., comparison
(All dollar amounts in millions)
Accounts receivable (net)
Net sales
Receivables turnover
Average collection period
Symantec Corp.
CA, Inc.
2011
2010
2011
2010
$
1,013 $
856 $
849 $
931
6,190
4,429
Symantec Corp
6.62
55.14 days
CA, Inc
4.98
73.29 days
Industry Average
5.96
61.3 days
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
When a company holds a receivable from
another company, there is some potential that
the receivable will eventually be impaired.
Impairment of a receivable
occurs if the company believes
it is probable that it will not
receive all of the cash flows
(principal and any interest
payments) associated with the
receivable.
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
Bad debt expense
Accrued interest receivable
Allowance for uncollectible accounts
($30,000,000 - $24,132,330)
8,867,670
3,000,000
5,867,670
Appendix 7-B: Accounting for Impairment of a
Receivable and a Troubled Debt Restructuring
A troubled debt restructuring occurs when a
creditor makes concessions in response to a debtor’s
financial difficulties.
Sometimes a receivable in a troubled debt restructuring is actually settled at
the time of the restructuring by the debtor making a payment of cash, some
other noncash assets, or even shares of the debtor’s stock.
Land (fair value)
Bad debt expense
Accrued interest receivable
Notes receivable
(in millions)
20
13
3
30
U.S. GAAP vs. IFRS
The U.S. GAAP and the IFRS approaches to impairments
of receivables are similar, but the process and criteria are
somewhat different.

Under U.S. GAAP the level of analysis is
individual receivables.

U.S. GAAP provides an illustrative list of
information to consider when evaluating
receivables for impairment, and requires
measurement of potential impairment if
impairment (a) is viewed as probable and
(b) can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of
impairments the same.

Under IFRS the level of analysis starts with
consideration of impairment for
individually significant receivables.

IFRS provides an illustrative list of “loss
events” and requires measurement of an
impairment if there is objective evidence
that a loss event has occurred that has an
impact on the future cash flows collected
and that can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of
impairments the same.
End of Chapter 7