Chapter 7
Cash and Receivables
Copyright © 2015 McGraw-Hill Education. All rights reserved.
Cash and Cash Equivalents
Cash
•
•
Amounts readily
available to pay off
debt or to use in
operations
Examples: Currency
and coins, balances in
checking accounts
Cash
equivalents
• Short-term, highly liquid
investments, readily
convertible to cash with
little risk of loss
• Have a maturity date no
longer than three months
from the date of purchase
• Examples: Money market
funds, treasury bills, and
commercial paper
Disclosure of Cash Equivalents—Walgreen Co.
LO7-1
Internal Control
To encourage
adherence to
company policies
and procedures
To promote
operational
efficiency
Internal Control
To minimize errors
and theft
To enhance the
reliability and
accuracy of
accounting data
LO7-1
Internal Control
• Sarbanes-Oxley Act (Section 404) requires:
o A company to document and assess its internal
controls
o Auditors to express an opinion on management’s
assessment
• Committee of Sponsoring Organizations (COSO):
o Defines internal control as a process designed to
provide reasonable assurance regarding the
achievement of objectives in the following:
– Effectiveness and efficiency of operations
– Reliability of financial reporting
– Compliance with applicable laws and regulations
LO7-1
Internal Control Procedures—Cash Receipts
• Separation of duties in the cash receipts process:
Step 1: Employee A opens the mail each day and
prepares a multicopy listing of all checks including
the amount and payor’s name
Step 2: Employee B takes the checks, along with one
copy of the listing, to the person responsible for
depositing the checks in the company’s bank account
Step 3: A second copy of the check listing is sent to
the accounting department where Employee C
enters receipts into the accounting records
LO7-1
Internal Control Procedures—
Cash Disbursements
•
Objective
•
To prevent unauthorized
payments
To ensure that disbursements are
recorded properly
Important elements:
•
•
•
All disbursements should be made by check
All expenditures should be authorized
Checks should be signed only by authorized
individuals
LO7-2
Restricted Cash
• Cash that is restricted in some way and not
available for current use
Specific purpose
Purpose:
Example: For future plant expansion
Contractually imposed
Example:
Debt instruments require the borrower to set aside funds
If Debt
Noncurrent; then Restricted cash
Noncurrent
If Debt
Current; then Restricted cash
Current
LO7-2
Compensating Balances
• An amount that compensates the bank for granting
the loan or extending the line of credit
• Under this arrangement:
o Borrower is asked to maintain a specified
balance in a low interest or noninterest-bearing
account at the bank
o Required balance equals some percentage of the
committed amount
o Borrower pays effective interest rate higher than
the stated rate on the debt
LO7-2
Effective Interest Rate Higher Than the Stated
Rate on the Debt
A company borrows $10,000,000 from a bank at an
interest rate of 12%. The bank requires a compensating
balance of $2,000,000 to be held in a noninterestbearing checking account.
Total borrowing from bank
Interest ($10,000,000 × 12%)
$10,000,000
$ 1,200,000
Actual borrowing ($10,000,000 − $2,000,000) $ 8,000,000
Effective rate of interest ($1,200,000 ÷ 8,000,000)
15%
15% > 12%
Concept Check √
Jenks borrowed $13,000,000 from a bank at a 10% rate of interest. The
bank requires Jenks to maintain a $3,000,000 compensating balance. What
is Jenks’ effective interest rate?
a. 7.7%.
b. 10%.
c. 13%.
d. 23%.
($13,000,000 × 10%) = $1,300,000 = annual interest paid
$1,300,000 ÷ ($13,000,000 - $3,000,000) = 13% = effective interest rate
LO7-3
Trade Discounts and Cash Discounts
Trade
Discounts
• A percentage reduction from the list price
• Quantity discounts to large customers
Cash
Discounts
•
•
Reductions in the amount to be paid by a credit
customer if paid within a specified period of time
Intended to provide incentive for quick payment
2/10, n/30 — meaning a 2% discount if paid within
10 days, otherwise full payment within 30 days
LO7-3
Cash Discounts: Gross Method vs. Net Method
Cash Discounts
Gross Method
Net Method
Gross amount
Net amount after discount
Discount not taken by the
customer
Discounts not taken by the
customer
Sales revenue
Interest revenue
LO7-3
Illustration: Gross Method vs. Net Method
The Hawthorne Manufacturing Company offers credit customers a 2%
cash discount if the sales price is paid within 10 days. Any amounts not
paid within 10 days are due in 30 days. These repayment terms are
stated as 2/10, n/30. On October 5, 2016, Hawthorne sold merchandise
at a price of $20,000. The customer paid $13,720 ($14,000 less the 2%
cash discount) on October 14 and the remaining balance of $6,000 on
November 4.
Journal Entry-October 5, 2016
Gross Method
Accounts receivable
Sales revenue
Net Method
Accounts receivable ($20,000 x 98%)
Sales revenue
Debit
20,000
Credit
20,000
19,600
19,600
LO7-3
Gross Method vs. Net Method
(Illustration continued)
The Hawthorne Manufacturing Company offers credit customers a 2%
cash discount if the sales price is paid within 10 days. Any amounts not
paid within 10 days are due in 30 days. These repayment terms are
stated as 2/10, n/30. On October 5, 2016, Hawthorne sold merchandise
at a price of $20,000. The customer paid $13,720 ($14,000 less the 2%
cash discount) on October 14 and the remaining balance of $6,000 on
November 4.
Journal Entry-October 14, 2016
Gross Method
Cash
Sales discounts
Accounts receivable
Net Method
Cash
Accounts receivable
Debit
Credit
13,720
280
14,000
13,720
13,720
LO7-3
Gross Method vs. Net Method
(Illustration continued)
The Hawthorne Manufacturing Company offers credit customers a 2%
cash discount if the sales price is paid within 10 days. Any amounts not
paid within 10 days are due in 30 days. These repayment terms are
stated as 2/10, n/30. On October 5, 2016, Hawthorne sold merchandise
at a price of $20,000. The customer paid $13,720 ($14,000 less the 2%
cash discount) on October 14 and the remaining balance of $6,000 on
November 4.
Journal Entry-November 4, 2016
Gross Method
Cash
Accounts receivable
Net Method
Cash
Accounts receivable
Interest revenue
Debit
6,000
6,000
Credit
6,000
5,880
120
LO7-3
Gross Method vs. Net Method
(Illustration continued)
The Hawthorne Manufacturing Company offers credit customers a 2%
cash discount if the sales price is paid within 10 days. Any amounts not
paid within 10 days are due in 30 days. These repayment terms are
stated as 2/10, n/30. On October 5, 2016, Hawthorne sold merchandise
at a price of $20,000. The customer paid $13,720 ($14,000 less the 2%
cash discount) on October 14 and the remaining balance of $6,000 on
November 4.
Sales
Less: Sales discounts
Net sales revenue
Interest revenue
Total revenue
Gross Method
$20,000
(280)
19,720
0
$19,720
Net Method
$19,600
-019,600
120
$19,720
Concept Check √
Which of the following is not true about recording cash discounts?
a. The gross method records sales discounts taken when payment occurs
during the discount period.
b. The net method records sales discounts not taken as interest revenue.
c. Net sales revenue is higher under the gross method than under the net
method.
d. Total revenue is higher under the gross method than under the net
method.
Total revenue is the same under the two methods. See the previous
illustration: $19,720 (gross method) = $19,600 + $120 (net method).
LO7-4
Subsequent Valuation of Accounts Receivable
Two situations could cause the cash ultimately
collected to be less than the initial valuation of the
receivable:
1) Returns: The customer could return the product
2) Bad Debts: The customer could default and not
pay the agreed-upon sales price.
LO7-4
Sales Returns
• Situation when merchandise is returned for a
refund or for credit to be applied to other
purchases
• Special price reduction, called an allowance, may
be given as an incentive for the customer to keep
the merchandise rather than returning it
• We need to accrue sales returns and allowances at
the time of sale.
– Otherwise, recognizing sales returns when they
occur could result in overstated income in the
period of sale and understated income in the
return period
LO7-4
Illustration: Accounting for Sales Returns
During 2016, its first year of operations, the Hawthorne Manufacturing
Company sold merchandise for $2,000,000. This merchandise cost
Hawthorne $1,200,000 (60% of the selling price). Industry experience
indicates that 10% of all sales will be returned, which in this case equals
$200,000 ($2,000,000 × 10%). Customers returned $130,000 of sales
during 2016. Hawthorne uses a perpetual inventory system.
Sales of $2,000,000 occurred in 2016, with cost of goods sold of $1,200,000
Assuming Hawthorne received cash
at the time of sales:
Cash
Sales revenue
COGS
Inventory
Assuming Hawthorne recorded accounts
receivable at the time of sales that have
not yet been collected:
2,000,000
Acc. receivable
2,000,000
2,000,000
Sales revenue
2,000,000
1,200,000
COGS
1,200,000
Inventory
1,200,000
1,200,000
LO7-4
Accounting for Sales Returns
(Illustration continued)
During 2016, its first year of operations, the Hawthorne Manufacturing
Company sold merchandise for $2,000,000. This merchandise cost
Hawthorne $1,200,000 (60% of the selling price). Industry experience
indicates that 10% of all sales will be returned, which equals $200,000
($2,000,000 × 10%) in this case. Customers returned $130,000 of sales
during 2016. Hawthorne uses a perpetual inventory system.
Sales returns of $130,000 occurred during 2016. The cost of returned
inventory is $78,000 ($130,000 × 60%)
Assuming Hawthorne received cash at Assuming Hawthorne recorded accounts
the time of sales:
receivable at the time of sales that have
not yet been collected:
Sales returns
130,000
Sales returns
130,000
Cash
130,000
Acc. receivable
130,000
Inventory
COGS
78,000
Inventory
78,000
COGS
78,000
78,000
LO7-4
Accounting for Sales Returns
(Illustration continued)
During 2016, its first year of operations, the Hawthorne Manufacturing
Company sold merchandise for $2,000,000. This merchandise cost
Hawthorne $1,200,000 (60% of the selling price). Industry experience
indicates that 10% of all sales will be returned, which equals $200,000
($2,000,000 × 10%) in this case. Customers returned $130,000 of sales
during 2016. Hawthorne uses a perpetual inventory system.
At the end of 2016, an additional $70,000 of sales returns are expected. The
cost of the inventory expected to be returned is $42,000 ($70,000 × 60%)
Assuming Hawthorne recorded accounts
Assuming Hawthorne received cash at receivable at the time of sales that have
the time of sales:
not yet been collected:
Sales returns
70,000
Sales returns
70,000
Refund Liability
70,000 Allow. for S. returns
70,000
Inventory–est. returns 42,000
Inventory–est. returns 42,000
COGS
42,000
COGS
42,000
LO7-4
Accounting for Sales Returns
(Illustration continued)
During 2016, its first year of operations, the Hawthorne Manufacturing
Company sold merchandise for $2,000,000. This merchandise cost
Hawthorne $1,200,000 (60% of the selling price). Industry experience
indicates that 10% of all sales will be returned, which equals $200,000
($2,000,000 × 10%) in this case. Customers returned $130,000 of sales
during 2016. Hawthorne uses a perpetual inventory system.
Sales returns of $70,000 occurred during 2017. The cost of returned
inventory is $42,000.
Assuming Hawthorne recorded accounts
Assuming Hawthorne received cash at receivable at the time of sales that have
the time of sales:
not yet been collected:
Refund Liability
70,000
Allow. for S. returns
70,000
Cash
70,000 Acc. receivable
70,000
Inventory
42,000
Inventory
42,000
Inventory–est. returns
42,000
Inventory–est. returns
42,000
Concept Check √
Five Dollar Stores (FDS) sells merchandise for cash. It began 2016 with a
refund liability of $0, made sales of $1,000,000 during 2016 which cost FDS
$600,000 (or 60%), estimates that 1% of all sales will be returned, and
experiences $8,000 of returns during 2016. When accruing its estimate of
remaining returns at the end of 2016, FDS would debit sales returns and
credit the refund liability for:
a.
b.
c.
d.
$18,000.
$10,000.
$8,000.
$2,000.
Total estimated returns =
$1,000,000 × 1% = $10,000.
Estimated returns to accrue =
$10,000 - $8,000 = $2,000.
Sales returns
Refund liability
2,000
2,000
Concept Check √
Five Dollar Stores (FDS) sells merchandise for cash. It began 2016 with a
refund liability of $0, made sales of $1,000,000 during 2016 which cost FDS
$600,000 (or 60%), estimates that 1% of all sales will be returned, and
experiences $8,000 of returns during 2016. When accruing its estimate of
remaining returns at the end of 2016, FDS would debit Inventory—
estimated returns and credit COGS for:
a.
b.
c.
d.
$6,000.
$4,800.
$1,200.
$0.
Total estimated returns =
$1,000,000 × 1% = $10,000.
Estimated returns to accrue =
$10,000 - $8,000 = $2,000.
Estimated cost of returns to accrue =
$2,000 × 60% = $1,200
Sales returns
Refund liability
Inventory—estimated returns
COGS
2,000
2,000
1,200
1,200
LO7-4
Sales Returns (Damaged or Defective)
Sales Returns
Merchandise unable
to satisfy the
customer’s needs
Defective or
damaged during
shipment
• Should be included in a company’s estimate of
returns
• To be valued at the lower of cost and net realizable
value
LO7-4
Accounting Treatment for Merchandise Returns
• If the estimate of future sales returns turns out to
be wrong, the new estimate is incorporated into
accounting determinations in the next period
Suppose in our illustration that in 2017 actual returns from 2016
sales are $60,000 instead of $70,000.
Journal Entry-2017
Allowance for sales returns
Sales returns
Cost of goods sold
Inventory—estimated returns
Debit
10,000
Credit
10,000
6,000
6,000
LO7-5
Uncollectible Accounts Receivable
• Some customers default their payment
• Bad debt expense:
o Inherent cost of granting credit
o Operating expense incurred to make sales
• Recognizing bad debt expense results in reporting
accounts receivable at their net realizable value
• Accounting for bad debts: By allowance method
Disclosure of Accounts Receivable
LO7-6
Two Approaches to Estimating Bad Debts
Estimation of Bad Debts
Income statement
approach
o
o
o
Estimates bad debt
expense as a percentage of
each period’s net credit
sales
Existing companies use past
data to determine this
percentage
New companies use
industry averages
Balance sheet
approach
o
o
Determines bad debt expense by
estimating the net realizable
value of accounts receivable
Estimation done by applying:
• a percentage to the entire
outstanding receivable balance
or
• accounts receivable aging
schedule
LO7-6
Illustration: Income Statement Approach
The Hawthorne Manufacturing Company sells its products
offering 30 days’ credit to its customers. During 2016, its first year
of operations, the following events occurred:
Sales on credit
$ 1,200,000
Cash collections from credit customers
(895,000)
Accounts receivable, end of year
$ 305,000
There were no specific accounts determined to be uncollectible in
2016. The company anticipates that 2% of all credit sales will
ultimately become uncollectible.
2% × $1,200,000 = $24,000
Journal Entry
Bad debt expense
Allowance for uncollectible accounts
Debit
24,000
Credit
24,000
LO7-6
Income Statement Approach
(Illustration continued)
The Hawthorne Manufacturing Company sells its products
offering 30 days’ credit to its customers. During 2016, its first year
of operations, the following events occurred:
Sales on credit
$ 1,200,000
Cash collections from credit customers
(895,000)
Accounts receivable, end of year
$ 305,000
There were no specific accounts determined to be uncollectible in
2016. The company anticipates that 2% of all credit sales will
ultimately become uncollectible.
Accounts receivable
Less: Allowance for uncollectible accounts
Net accounts receivable
$
$
305,000
(24,000)
281,000
2% × $1,200,000 = $24,000
LO7-6
Balance Sheet Approach
(Illustration continued)
LO7-6
Using Two Approaches Together
Sales on credit
Accounts receivable, end of year
Allowance for uncollectible accounts
$120,000
$305,000
$25,500
Accounts Receivable
305,000
Allowance for Uncollectible Accounts
24,000
1,500
25,500
Journal Entry
Bad debt expense ($25,500 – $24,000)
Allowance for uncollectible accounts
Bad Debt Expense
24,000
1,500
25,500
Debit
1,500
Credit
1,500
LO7-6
Using Two Approaches Together
(Illustration continued)
Sales on credit
Accounts receivable, end of year
Allowance for uncollectible accounts
Journal Entry
Bad debt expense
Allowance for uncollectible accounts
Accounts receivable
Less: Allowance for uncollectible accounts
Net accounts receivable
$120,000
$305,000
$25,500
Debit
1,500
$
$
Credit
1,500
305,000
(25,500)
279,500
LO7-6
When Accounts Are Deemed Uncollectible
Sales on credit
Accounts receivable, end of year
Allowance for uncollectible accounts
Actual bad debts in 2017
$120,000
$305,000
$25,500
$25,000
Allowance for Uncollectible Accounts
25,500
25,000
500
Journal Entry
Allowance for uncollectible accounts
Accounts receivable
Accounts receivable
Less: Allowance for uncollectible accounts
Net accounts receivable
Debit
Credit
25,000
25,000
$
$
280,000
(500)
279,500
LO7-6
If Previously Written-Off Accounts Are Collected
Sales on credit
$120,000
Accounts receivable, end of year
$305,000
$25,500
Allowance for uncollectible accounts
$25,000
Actual bad debts in 2017
Assume that in our illustration, $1,200 that was written off is
collected.
Journal Entry-2016
Accounts receivable
Allowance for uncollectible accounts
Debit
Credit
1,200
1,200
To reinstate the receivable previously written off.
Cash
Accounts receivable
To record the cash collection.
1,200
1,200
LO7-6
Direct Write-Off of Uncollectible Accounts
Sales on credit
$120,000
Accounts receivable, end of year
$305,000
$25,500
Allowance for uncollectible accounts
$25,000
Actual bad debts in 2017
Assume that in our illustration $750 of uncollectible accounts
was not anticipated.
Journal Entry-2016
Bad debt expense
Accounts receivable
Debit
Credit
750
750
LO7-6
Measuring and Reporting Accounts Receivable
Concept Check √
Berkley Associates uses the balance sheet approach to estimate bad debts
expense. It started 2016 with a credit balance of $10,000 in its allowance
for uncollectible accounts. Berkley wrote off $200,000 of bad debts during
2016, and its aging of accounts receivable at 12/31/16 indicates it should
have a credit balance of $5,000 in the allowance for uncollectible accounts.
No other journal entries to the allowance have been made. Berkley’s
journal entry to record bad debts expense should include a:
a. Debit to B.D. expense of $195,000.
$ 10,000 beginning balance
b. Debit to the allowance for $5,000.
- 200,000 written off
c. Credit to B.D. expense for $200,000.
+ bad debt expense (= $195,000)
d. Credit to the allowance for $200,000.
$ 5,000 ending balance.
Bad debt expense
195,000
Allowance for uncollectible accounts 195,000
LO7-7
Notes Receivable
Creditor
Notes:
Debtor
Formal credit arrangements
From loans to other
entities/ to stockholders
and employees
From the extension of the
credit period to trade
customers
LO7-7
Interest-Bearing Notes
Interest-Bearing
Notes
Interest on notes:
Payment
Principal
+
Interest
LO7-7
Illustration: Interest-Bearing Notes
The Stridewell Wholesale Shoe Company manufactures athletic
shoes that it sells to retailers. On May 1, 2016, the company sold
shoes to Harmon Sporting Goods. Stridewell agreed to accept a
$700,000, 6-month, 12% note in payment for the shoes. Interest is
payable at maturity. Assume that an interest rate of 12% is
appropriate for a note of this type. $700,000 × 12% × (6/12) = $42,000
Journal Entry
May 1, 2016
Note receivable
Sales revenue
November 1, 2016
Cash
Interest revenue
Note receivable
Debit
Credit
700,000
700,000
742,000
42,000
700,000
LO7-7
Interest-Bearing Notes
(Illustration continued)
The Stridewell Wholesale Shoe Company manufactures athletic
shoes that it sells to retailers. On August 1, 2016, the company
sold shoes to Harmon Sporting Goods. Stridewell agreed to accept
a $700,000, 6-month, 12% note in payment for the shoes. Interest
is payable at maturity. Assume that an interest rate of 12% is
appropriate for a note of this type. $700,000 × 12% × (5/12) = $35,000
Journal Entry
December 31, 2016
Interest receivable
Interest revenue
February 1, 2017
Cash
Interest revenue
Interest receivable
Note receivable
Debit
Credit
35,000
35,000
742,000
7,000
35,000
700,000
LO7-7
Noninterest-Bearing Notes
• Noninterest-bearing notes really do have interest
associated with them.
• Interest is discounted from the face amount to
determine the cash proceeds made available to the
borrower at the outset
• The discount on note receivable:
o represents future interest revenue that will be
recognized as it is earned over time
o is a contra account to the note receivable account
LO7-7
Illustration: Noninterest-Bearing Notes
Stridewell Wholesale Shoe Company sold shoes to Harmon
Sporting Goods on May 1, 2016, accepting a $700,000, 6-month,
noninterest-bearing note with a 12% discount rate in payment for
$700,000 × 12% × (6/12) = $42,000
the shoes.
Journal Entry
May 1, 2016
Note receivable
Discount on note receivable
Sales revenue
November 1, 2016
Discount on note receivable
Interest revenue
Cash
Note receivable
Debit
Credit
700,000
42,000
658,000
42,000
42,000
700,000
700,000
LO7-7
Effective Interest Rate on
Noninterest-Bearing Notes
(Illustration continued)
Stridewell Wholesale Shoe Company sold shoes to Harmon
Sporting Goods on May 1, 2016, accepting a $700,000, 6-month,
noninterest-bearing note with a 12% discount rate in payment for
the shoes. What effective interest rate is Harmon paying?
$ 42,000
÷ $658,000
= 6.383%
×
2
= 12.766%
Interest for 6 months
Sales price
Rate for 6 months
To annualize the rate
Effective interest rate
LO7-7
Noninterest-Bearing Notes
(Illustration continued)
Stridewell Wholesale Shoe Company sold shoes to Harmon
Sporting Goods on August 1, 2016, accepting a $700,000,
6-month, noninterest-bearing note with a 12% discount rate in
payment for the shoes.
Journal Entry
December 31, 2016
Discount on note receivable
Interest revenue ($700,000 × 12% ×
February 1, 2017
Discount on note receivable
Interest revenue ($700,000 × 12% ×
Cash
Note receivable
Debit
Credit
35,000
5/12 = $35,000)
35,000
7,000
1/12 = $7,000)
7,000
700,000
700,000
LO7-7
Illustration: Long-Term Notes Receivable
Stridewell Shoe Company sold shoes to Harmon Sporting Goods
on January 1, 2016, accepting a $700,000, two-year note in
payment for the shoes. Assuming a 12% effective interest rate.
Journal Entry
Credit
Debit
January 1, 2016
Notes receivable
700,000
Discount on note receivable
Present value of $1; 141,964
n =2, i =12%
Sales revenue (700,000 × 0.79719)
558,036
December 31, 2016
Discount on note receivable
66,964
Interest revenue (558,036 × 12%)
66,964
December 31, 2017
700,000
Cash
75,000
Discount on note receivable
Interest revenue ((558,036 + 66,964) × 12%)
75,000
Note receivable
700,000
Concept Check √
Finkel sold merchandise to a customer in exchange for a four year,
noninterest-bearing note for $10,000. An equivalent loan would have a
10% interest rate. Finkel would record sales revenue on the date of sale
equal to:
a. $0.
b. $10,000.
c. The present value of $10,000, discounted at a 10% discount rate for
four years.
d. $9,000, equal to $10,000 – (10% x $10,000).
The amount of $10,000 includes both sales revenue and
interest revenue associated with Finkel’s loan to the
customer. Sales revenue is the present value of the
note, with the remainder being interest revenue.
LO7-7
Illustration: Notes Received Solely for Cash
The Stridewell Wholesale Shoe Company loaned $700,000 to
Harmon Sporting Goods. Stridewell agreed to accept a $700,000,
two-year note in exchange for loaning $700,000 to Harmon. The
transaction would be recorded as follows:
Journal Entry
Note receivable
Cash
Debit
700,000
Credit
700,000
Stridewell would not record interest revenue in future periods.
When Harmon pays off the note in two years, Stridewell would
record the reverse of the journal entry shown above.
LO7-7
Subsequent Valuation of Notes Receivable
• If a company anticipates bad debts on short-term notes
receivable, it uses an allowance account to reduce the
net realizable value.
($ in millions)
Loans
Allowance for loan losses
Net loans
December 31,
2013
$825,799
14,502
$811,297
December 31,
2012
$799,574
17,060
$782,514
• Companies can choose to carry receivables at fair value
in their balance sheets, with changes in fair value
recognized as gains or losses in the income statements.
LO7-8
Financing with Receivables
Financing with Receivables




Secured Borrowing
Pledge accounts receivable
as collateral for a loan
Entire receivables balance
serves as collateral
Responsibility for collection
of the receivables remains
solely with the company
The arrangement should be
described in a disclosure
note
 No special accounting
treatment is needed
Sale of Receivables
 Can be sold at a gain or a
loss like other assets
 Accounting treatment is
similar to that of the sale of
other assets
LO7-8
Secured Borrowing
• The loan amount is less then that of the
receivables assigned for collateral
• This difference provides protection against the
uncollectible accounts
• Lender charges an up-front finance charge in
addition to stated interest
• Collection of receivables can be done either by
borrower or lender based on the agreement
LO7-8
Illustration: Secured Borrowing -Assignment of Accounts Receivable
On December 1, 2016, 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.
Journal Entry
Cash
Finance charge expense
Liability—financing arrangement
Debit
490,700
9,300
$620,000 × 1.5% = $9,300
Credit
500,000
LO7-8
Secured Borrowing –
Assignment of Accounts Receivable
(Illustration continued)
Santa Teresa 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. Assume $400,000 of the receivables assigned are
collected in December.
Journal Entry
Cash
Accounts receivable
Interest expense
Liability—financing arrangement
Cash
($500,000 × 12% × 1⁄12)
Debit
400,000
Credit
400,000
5,000
400,000
405,000
LO7-8
Secured Borrowing –
Assignment of Accounts Receivable
Accounts Receivable
620,000
400,000
220,000
(Illustration continued)
Note Payable
500,000
400,000
100,000
Current Assets:
Accounts receivable assigned
Less: Liability—financing arrangement
Net accounts receivable
$
220,000
(100,000)
$
120,000
Concept Check √
Jada Co. borrows $100,000 on January 1 from NorthEast Bank at a 12%
interest rate. Jada assigned $140,000 of its accounts receivable as
collateral, and agreed to pay a financing fee of 2% of accounts receivable
assigned. On January 1, Jada’s accounting for this transaction will include:
a. Debit to cash for $100,000.
b. Debit to cash for $97,200.
c. Debit to finance expense of $2,000.
d. Debit to finance expense of $1,000.
The journal entry recorded on January 1 would be:
Cash (to balance)
97,200
Finance expense ($140,000 x 2%)
2,800
Liability—financing arrangement
100,000
LO7-8
Sale of Receivables
Accounting treatment:
Removes
• The
receivables
from the
accounts
Records
The Seller
• The
difference as
a gain or
loss
Recognizes
• At fair value any assets acquired or
liabilities assumed by the seller in
the transaction
LO7-8
Sale of Receivables
Factoring arrangement
Sells accounts receivables
Company
•
•
Factor
Financial institution
Buys accounts receivables
Charges a fee for this service
Responsibility:
 Billing  Collection
LO7-8
Sale of Receivables
Securitization
Company
Trade
receivables
Related securities,
typically debt such as
 bonds or
 commercial paper
Loans
Sells
Buys
SPE
Credit card
receivables
LO7-8
Illustration: Factoring and Securitization
Advertisement of Factoring Service:
Description of Securitization Program:
Illustration:
Accounts Receivable Factored Without Recourse
LO7-8
In December 2016, 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. Factor retains the remaining
10% to cover its factoring fee (equal to 4% of the total factored amount) and to
provide a cushion against potential sales returns and allowances. After Factor
has collected cash equal to the amount advanced to Santa Teresa plus their
factoring fee, Factor remits the excess to Santa Teresa. Therefore, under this
arrangement Factor provides Santa Teresa 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 management estimates to equal
$50,000), less the 4% factoring fee.
Journal Entry
Cash (90% × $600,000 = $540,000)
Loss on sale of receivables
Receivable from factor ($50,000 - $24,000)
Accounts receivable
Debit
540,000
34,000
26,000
Credit
600,000
Illustration:
Accounts Receivable Factored with Recourse
LO7-8
Assume the same facts as in the previous Illustration, except
that Santa Teresa sold the receivables to Factor with
recourse and estimates the fair value of the recourse
obligation to be $5,000.
Journal Entry
Cash
Loss on sale of receivables
Receivable from factor
Recourse liability
Accounts receivable
Debit
540,000
39,000
26,000
Credit
5,000
600,000
Concept Check √
Which of the following is not true about factoring receivables?
a. Cash received upon transfer is less than the amount of receivables
transferred.
b. A transfer without recourse means that the transferor bears the risk of
the receivables not being collected.
c. A larger loss is recorded by the transferor when receivables are
transferred with recourse.
d. The transferor removes that accounts receivable from its balance
sheet.
Under a transfer with recourse, the transferee can go back to the
transferor for payment if receivables default, so the transferor bears the
risk of the receivables not being collected, recognizing a recourse
liability and a larger loss on the factoring arrangement. If the transfer is
without recourse, the transferee cannot go back to the transferor for
payment, so it is the transferee that bears the risk of default.
LO7-8
Transfers of Notes Receivable (Discounting)
• Companies can obtain immediate cash from a
financial institution either by pledging the note as
collateral for a loan or by selling the note
Note
Company
Financial
institution
Cash =
Maturity value of note – Discount
Financing fee
LO7-8
Illustration: Transfers of Notes Receivable (Discounting)
On December 31, 2016, the Stridewell Wholesale Shoe Company sold
land in exchange for a nine-month, 10% note. The note requires the
payment of $200,000 plus interest on September 30, 2017. The
company’s fiscal year-end is December 31. The 10% rate properly
reflects the time value of money for this type of note. On March 31,
2017, Stridewell discounted the note at the Bank of the East. The bank’s
discount rate is 12%.
Journal Entry-March 31, 2017
Interest receivable
Interest revenue
Debit
Credit
5,000
5,000
STEP 1: Accrue interest earned on the note receivable prior to its being discounted
$ 200,000 Face amount
5,000 Accrued Interest for 1/1-3/31 ($200,000 × 10% × 3⁄12)
LO7-8
Transfers of Notes Receivable
(Illustration continued)
On December 31, 2016, the Stridewell Wholesale Shoe Company sold
land in exchange for a nine-month, 10% note. The note requires the
payment of $200,000 plus interest on September 30, 2017. The
company’s fiscal year-end is December 31. The 10% rate properly
reflects the time value of money for this type of note. On March 31,
2017, Stridewell discounted the note at the Bank of the East. The bank’s
discount rate is 12%.
STEP 2: Add interest to maturity to calculate maturity value
STEP 3: Deduct discount to calculate cash proceeds
$ 200,000 Face amount
15,000 Interest to maturity ($200,000 × 10% × 9⁄12)
215,000 Maturity value
(12,900) Discount ($215,000 × 12% × 6⁄12)
$ 202,100 Cash proceeds
Concept Check √
On June 1, 2016, Detert accepted a six-month note paying $100,000 plus
8% interest in exchange for services rendered. Detert immediately
discounted the note at SouthBank, paying a 10% discount rate. On June 1,
Detert will receive how much cash from SouthBank?
a. $97,200.
b. $98,800.
c. $100,000.
d. $108,000.
Maturity value = $100,000 x 8% x 6/12 = $104,000.
Discount = $104,000 x 10% x 6/12 = $5,200.
Cash proceeds = $104,000 - $5,200 = $98,800.
LO7-8
Transfers of Notes Receivable
(Illustration continued)
On December 31, 2016, the Stridewell Wholesale Shoe Company
sold land in exchange for a nine-month, 10% note. The note
requires the payment of $200,000 plus interest on September 30,
2017. The company’s fiscal year-end is December 31. The 10%
rate properly reflects the time value of money for this type of
note. On March 31, 2017, Stridewell discounted the note at the
Bank of the East. The bank’s discount rate is 12%.
Accounting for the transfer as a sale of the note without recourse:
Journal Entry
Debit
Cash
202,100
Loss on sale of note receivable (to balance)
2,900
Note receivable
Interest receivable
Credit
200,000
5,000
LO7-8
Illustration: Preference for Transfer as a Sale
LO7-8
Considering Transfer of Receivables as Sale
When is a transferor allowed to treat a transfer as a sale?
When the company (the transferor) has surrendered control over
the assets transferred.
Conditions for viewing transfer of
control to have occurred:
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.
LO7-8
Accounting for the Financing of Receivables
LO7-8
Disclosures
• Information that transferors must provide in disclosures
include:
– The transfer
– Any continuing involvement with the transferred
assets
– Any ongoing risks to the transferor
– How fair values were estimated when recording the
transaction
– Any cash flows occurring between the transferor and
the transferee
– How any continuing involvement in the transferred
assets will be accounted for on an ongoing basis
LO7-9
Decision Makers’ Perspective:
Receivables Management
Initiatives that may involve receivables management for a
company:
• Changes in variables such as:
Level of sales
Nature of the product or service sold
Credit and collection policies (longer credit period
or offering cash discounts)
• Choice of financing alternatives:
Assigning
Factoring
Discounting receivables
LO7-9
Decision Makers’ Perspective:
Receivables Management
• The receivables turnover ratio and the related
average collection period ratios are designed to
monitor receivables
LO7-9
Receivables Turnover and Average Collection
Period—Symantec Corp. and CA, Inc.
($ in millions)
Symantec Corp.
CA, Inc.
2013
2012 2013
2012
Accounts receivable
(net)
Two-year averages
Net sales—2013
$ 1,031
$ 940
$ 856
$ 986
$6,906
Symantec Corp. CA, Inc.
$6,906
Receivables Turnover =
$985.5
= 7.01 times
Average Collection
Period
$ 902
$ 879
$4,643
Industry Average
$4,643
=
$879
= 5.28 times
7.16 times
365
365
=
7.01
5.28
= 52.07 days = 69.13 days
50.98 days
=
Concept Check √
Cambridge Associates’ financial statements list the following:
Accounts receivable as of 1/1/16: $200,000
Accounts receivable as of 12/31/16: $600,000
Net sales for 2016: $8,000,000
Net sales for 2015: $10,000,000
Cambridge’ s 2016 average collection period is:
a. 9.125.
b. 16.22.
A/R turnover: $8,000,000 ÷ (($200,000 + $600,000) ÷ 2) = 20
c. 18.25.
Average collection period = 365 ÷ 20 = 18.25 days.
d. 27.375.
LO7-10
International Financial Reporting Standards
U.S. GAAP
IFRS
Cash and Cash Equivalents (bank overdrafts)
Overdrafts should be treated as liability It allows overdrafts to be offset
Requires assets and liabilities to be
Liabilities can be offset against other cash
stated separately on balance sheet
accounts and stated at their net value on
the balance sheet
“Fair value option” for accounting for receivables
Allow a “fair value option” for
Restrict the circumstances in which that
accounting for receivables
option is allowed
Accounting for receivables as “available for sale” investments:
Allows “available for sale” accounting
Does not allow that option for receivables
only for investments in securities
Requires more disaggregation of
Does not require separate disclosure
accounts and notes receivable in the
balance sheet or notes
Estimation of bad debts:
CECL model, bad debts are estimated by ECL model reports a “12-month ECL”
comparing the balance in the receivable
to the present value of cash flows
expected to be received
LO7-10
International Financial Reporting Standards
U.S. GAAP
IFRS
Transfers of Receivables:
Focuses on whether control of assets
has shifted from the transferor to the
Requires a more complex decision process
transferee
Impairments: Level of analysis:
Requires us to examine impairment of Requires us to first consider whether
individual receivables
individually significant receivables are
impaired
Impairments: Impairment indicators
Provides an illustrative list of
Provides an illustrative list of “loss events”
information to consider while
and requires measurement of an
evaluating receivables for impairment impairment
Impairments: Reversal of impairments
Same as GAAP.
If an impaired receivable’s estimated
future cash flows improve, the creditor
recalculates the impairment and adjusts
the valuation allowance up or down as
appropriate.
APPENDIX-7A
Cash Controls: Bank Reconciliation
Compare
Cash book balance
Bank balance
Reconcile any
differences
Timing
differences
Errors
APPENDIX-7A
Bank Reconciliation—Reconciling Items
Step 1: Adjustments to Bank Balance
•
•
•
Add deposits outstanding
Deduct checks outstanding
Add or deduct bank errors
Step 2: Adjustments to Book Balance
•
•
•
•
Add collections by bank
Deduct service charges
Deduct NSF (nonsufficient funds) checks
Add or deduct company errors
APPENDIX-7A
Illustration: Bank Reconciliation
The Hawthorne Manufacturing Company maintains a general checking account at the
First Pacific Bank. First Pacific provides a bank statement and cancelled checks once a
month. The cutoff date is the last day of the month. The bank statement for the month
of May is summarized as follows:
Balance, May 1, 2016
Deposits
Checks processed
Service charges
NSF checks
Note payment collected by bank (includes $120 interest)
Balance, May 31, 2016
$32,120
82,140
(78,433)
(80)
(2,187)
1,120
$34,680
The company’s general ledger cash account has a balance of $35,276 at the end of May.
A review of the company records and the bank statement reveals the following:
1. Cash receipts not yet deposited totaled $2,965.
2. A deposit of $1,020 was made on May 31 that was not credited to the company’s
account until June.
3. All checks written in April have been processed by the bank. Checks written in May
that had not been processed by the bank total $5,536.
4. A check written for $1,790 was incorrectly recorded by the company as a $790
disbursement. The check was for payment to a supplier of raw materials.
APPENDIX-7A
Bank Reconciliation
(Illustration continued)
Step 1: Bank Balance to Corrected Balance
Balance per bank statement
Add: Deposits outstanding
Deduct: Checks outstanding
Corrected cash balance
$34,680
3,985
(5,536)
$33,129
Step 2: Book Balance to Corrected Balance
Balance per books
Add: Note collected by bank
$35,276
1,120
Deduct:
Service charges
(80)
NSF checks
(2,187)
Error—understatement of check
(1,000)
Corrected cash balance
$33,129
APPENDIX-7A
Bank Reconciliation
Journal Entry
Cash
Note receivable
Interest revenue
Journal Entry
Miscellaneous expense
Accounts receivable
Accounts payable
Cash
(Illustration continued)
Debit
1,120
Credit
1,000
120
Debit
80
2,187
1,000
Credit
3,267
Concept Check √
Jamal’s August 31 bank reconciliation includes the following information:
• 8/31/16 Balance in the general ledger for cash: $10,000
• Outstanding checks of $2,500.
• Deposits in transit of $1,000.
• Bank service charge of $50.
• A check by Jamal for $250 had been incorrectly recorded by Jamal as a
disbursement of $150.
Jamal’s corrected 8/31/16 cash balance is:
a. $9,350.
$10,000 – $50 – ($250 – $150) = $9,850.
b. $9,850.
Note: the outstanding checks and deposits in
transit are amounts that appropriately affected
c. $10,050.
the cash balance, so no adjustment is necessary.
d. $10,850.
APPENDIX-7A
Cash Controls: Petty Cash
Petty cash: A small amount of cash on hand to pay for
low-cost items
Cash from general checking account
$ Amount = Approximate
expenditures for the week/month
Petty Cash
Custodian
Petty Cash Fund
On presentation of appropriate
documentation
Disbursement of cash
$
APPENDIX-7A
Illustration: Petty Cash Fund
On May 1, 2016, the Hawthorne Manufacturing Company
established a $200 petty cash fund. John Ringo is designated as
the petty cash custodian. The fund will be replenished at the end
of each month. On May 1, 2016, a check is written for $200 made
out to John Ringo, petty cash custodian. During the month of
May, John paid bills totalling $160 summarized as follows: Postage
$40, Office supplies $35, Delivery charges $55, and Entertainment
$30.
Journal Entry-May 1, 2016
Petty Cash
Cash
Debit
200
Credit
200
APPENDIX-7A
Petty Cash Fund
(Illustration continued)
On May 1, 2016, the Hawthorne Manufacturing Company
established a $200 petty cash fund. John Ringo is designated as
the petty cash custodian. The fund will be replenished at the end
of each month. On May 1, 2016, a check is written for $200 made
out to John Ringo, petty cash custodian. During the month of
May, John paid bills totalling $160, which includes Postage $40,
Office supplies $35, Delivery charges $55, and Entertainment $30.
Journal Entry-May 31, 2016
Postage expense
Office supplies expense
Delivery expense
Entertainment expense
Cash
Debit
40
35
55
30
Credit
160
APPENDIX-7B
Accounting for Impairment of a Receivable
•
Impairment loss is recognized if the creditor believes it is
probable that it will not receive all of the cash flows that
have been promised by the debtor
Creditor
remeasures
the receivable
P. V. of Principal
P. V. of Interest
Discounted at
effective
interest rate
Records
Dr—Bad debt expense
Cr—Allowance for uncollectible accounts
If conditions
change in
future
(+)/(–) Bad debt expense
(+)/(–) Allowance for uncollectible accounts
APPENDIX-7B
Accounting for Impairment of a Receivable
and a Troubled Debt Restructuring
• Concessions to the debtor in response to the
debtor’s financial difficulties
Receivable
continued
Settled
outright
Modified
terms
APPENDIX-7B
Illustration: Receivable Impairment
Brillard Properties owes First Prudent Bank $30 million under a 10% note with two
years remaining to maturity. Due to Brillard’s financial difficulties, the previous year’s
interest ($3 million) was not paid. First Prudent estimates that it will not receive the $3
million of accrued interest, that it will receive only $2 million of interest in each of the
next two years, and that it will receive only $25 million of principal at the end of two
years.
Analysis
Previous Value
Accrued interest (10% × $30,000,000)
$
Principal
Book value of the receivable
New Value (Based on estimated cash flows to be received)
Present value of accrued interest to be received
$
Present value of future interest ($2 million × 1.73554)
Present value of estimated principal ($25 million × 0.82645)
Present value of the receivable
Loss Present value of an ordinary
Present value of $1:
annuity of $1: n = 2, i = 10%
n = 2, i = 10%
3,000,000
30,000,000
$
33,000,000
0
3,471,080
20,661,250
(24,132,330)
$
8,867,670
APPENDIX-7B
Receivable Impairment
(Illustration continued)
Analysis
Previous Value
Accrued interest (10% × $30,000,000)
$
Principal
Book value of the receivable
New Value (Based on estimated cash flows to be received)
Present value of accrued interest to be received
$
Present value of future interest ($ 2 million × 1.73554)
Present value of estimated principal ($25 million × 0.82645)
Present value of the receivable
Loss
Journal Entry
Bad debt expense
Accrued interest receivable
Allowance for uncollectible accounts
3,000,000
30,000,000
$
33,000,000
0
3,471,080
20,661,250
(24,132,330)
$
8,867,670
Debit
Credit
8,867,670
3,000,000
5,867,670
APPENDIX-7B
Illustration: Receivable Impairment with
Modified Terms
Brillard Properties owes First Prudent Bank $30 million under a 10% note with two
years remaining to maturity. Due to Brillard’s financial difficulties, the previous year’s
interest ($3 million) was not paid. First Prudent estimates that it will not receive the $3
million of accrued interest, that it will receive only $2 million of interest in each of the
next two years, and that it will receive only $25 million of principal at the end of two
years.
Analysis
Previous Value
Accrued interest (10% × $30,000,000)
$
Principal
Book value of the receivable
New Value (Based on restructured debt agreement)
Present value of accrued interest to be received
$
Present value of future interest ($2 million × 1.73554)
Present value of estimated principal ($25 million × 0.82645)
Present value of the receivable
Loss
3,000,000
30,000,000
$
33,000,000
0
3,471,080
20,661,250
(24,132,330)
$
8,867,670
APPENDIX-7B
Illustration: Debt Settled at the Time of a
Restructuring
First Prudent Bank is owed $30 million by Brillard Properties
under a 10% note with two years remaining to maturity. Due to
Brillard’s financial difficulties, the previous year’s interest
($3 million) was not received. The bank agrees to settle the
receivable (and accrued interest receivable) in exchange for
property having a fair value of $20 million.
Journal Entry-May 31, 2016
Land (fair value)
Bad debt expense
Accrued interest receivable
Note receivable
Debit
20
13
Credit
3
30
Concept Check √
Hendricks Corporation is owed $100,000 by Lanker Inc. under a 5% note
with one year remaining until maturity. Lanker has not paid the prior year
of interest, and Hendricks agrees to settle the receivable in exchange for
land that has a fair value of $104,000. Hendricks’ journal entry to record
the settlement would include a:
a. Debit to land for $100,000.
b. Credit to accrued interest receivable for $10,000.
c. Credit to gain of $4,000.
d. Debit to bad debt expense of $1,000.
The journal entry would be:
Land
104,000
Bad debt expense (to balance)
1,000
Accrued interest receivable ($100,000 x 5%)
5,000
Note receivable
100,000
Where We’re Headed
CECL (“Current Expected Credit Loss”) model
Requires creditors to
estimate impairments
based on predictions
about the future as well
as current and past events
So impairments may be
recognized even if no past
information or current
conditions suggest a problem
APPENDIX-7B
Where We’re Headed
Analysis
Previous Value
Accrued interest (10% × $30,000,000)
$
Principal
Book value of the receivable
New Value
Present value of accrued interest to be received
$
Present value of future interest ($ 2 million × 1.73554)
Present value of estimated principal ($25 million × 0.82645)
Present value of the receivable
Loss
Book value of the receivable
Expected loss
(25%) × $8,867,670
(75%) × $0 loss
Expected loss
Revised book value of the receivable
3,000,000
30,000,000
$
33,000,000
0
3,471,080
20,661,250
(24,132,330)
$
8,867,670
$ 33,000,000
$2,216,918
0
$ 2,216,918
$ 30,783,082
End of Chapter 7