Post on 21-Jan-2016
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7-1
Prepared by Coby Harmon
University of California, Santa Barbara
Intermediate Accounting
Intermediate Accounting
Prepared by Coby Harmon
University of California, Santa BarbaraWestmont College
INTERMEDIATE
ACCOUNTINGF I F T E E N T H E D I T I O N
Prepared byCoby Harmon
University of California Santa BarbaraWestmont College
kiesoweygandtwarfieldteam for success
7-2
PREVIEW OF CHAPTER
Intermediate Accounting15th Edition
Kieso Weygandt Warfield
7
7-3
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-4
Most liquid asset.
Standard medium of exchange.
Basis for measuring and accounting for all items.
Current asset.
Examples: coin, currency, available funds on deposit at
the bank, money orders, certified checks, cashier’s checks,
personal checks, bank drafts and savings accounts.
CashCash
LO 1 Identify items considered cash.
What is Cash?
7-5
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-6
Short-term, highly liquid investments that are both
CashCash
LO 2 Indicate how to report cash and related items.
Cash Equivalents
a) readily convertible to cash, and
b) so near their maturity that they present insignificant risk of changes in value.
Examples: Treasury bills, Commercial paper, and Money market funds.
Reporting Cash
7-7
Companies segregate restricted cash from “regular” cash.
Examples, restricted for:
(1) plant expansion, (2) retirement of long-term debt, and (3)
compensating balances.
Reporting CashReporting Cash
LO 2
Restricted Cash
Illustration 7-1
7-8
Company writes a check for more than the amount in its
cash account.
Reporting CashReporting Cash
LO 2 Indicate how to report cash and related items.
Bank Overdrafts
Generally reported as a current liability.
Offset against other cash accounts only when
accounts are with the same bank.
7-9
Cash-Related ItemsCash-Related Items
LO 2
Illustration 7-2
7-10
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-11
Accounts ReceivableAccounts Receivable
LO 3 Define receivables and identify the different types of receivables.
Written promises to pay a sum of money on a
specified future date.
Receivables - Claims held against customers and others for money, goods, or services.
Oral promises of the purchaser to pay for goods
and services sold.
Accounts Accounts ReceivableReceivableAccounts Accounts
ReceivableReceivableNotes Notes
ReceivableReceivableNotes Notes
ReceivableReceivable
7-12
Nontrade Receivables
1. Advances to officers and employees.
2. Advances to subsidiaries.
3. Deposits paid to cover potential damages or losses.
4. Deposits paid as a guarantee of performance or payment.
5. Dividends and interest receivable.
6. Claims against: Insurance companies for casualties sustained;
defendants under suit; governmental bodies for tax refunds; common carriers for damaged or lost goods; creditors for returned, damaged, or lost goods; customers for returnable items (crates, containers, etc.).
Accounts ReceivableAccounts Receivable
LO 3 Define receivables and identify the different types of receivables.
7-13
Accounts ReceivableAccounts Receivable
LO 3 Define receivables and identify the different types of receivables.
Illustration 7-3Receivables BalanceSheet Presentations
Nontrade Receivables
7-14
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-15
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Reductions from the list
price.
Not recognized in the
accounting records.
Customers are billed net
of discounts.
10 %
Discount for
new Retail
Store
Customers
Trade Discounts
7-16
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Offered to induce prompt
payment.
Gross Method vs. Net
Method.
Cash Discounts (Sales Discounts)
Payment terms are 2/10, n/30
7-17
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Illustration 7-4Cash Discounts (Sales Discounts)
7-18
Illustration: On June 3, Bolton Company sold to Arquette Company
merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. On June 12, the company received a check for the
balance due from Arquette Company. Prepare the journal entries on
Bolton Company books to record the sale assuming Bolton records sales
using the gross method.
Sales
2,000
Accounts Receivable 2,000June 3
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Cash ($2,000 x 98%) 1,960
Sales Discounts 40
Accounts Receivable 2,000
June 12
7-19
Illustration: On June 3, Bolton Company sold to Arquette Company
merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. On June 12, the company received a check for the
balance due from Arquette Company. Prepare the journal entries on
Bolton Company books to record the sale assuming Bolton records sales
using the net method.
Sales
1,960
Accounts Receivable 1,960June 3
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Cash ($2,000 x 98%) 1,960
Accounts Receivable 1,960
June 12
7-20
Illustration: On June 3, Bolton Company sold to Arquette Company
merchandise having a sale price of $2,000 with terms of 2/10, n/60, f.o.b.
shipping point. Prepare the journal entries on Bolton Company books to
record the sale assuming Bolton records sales using the net method, and
Arquette did not remit payment until July 29.
Sales
1,960
Accounts Receivable 1,960June 3
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
Cash 2,000
Accounts Receivable 1,960
Sales Discounts Forfeited 40
June 12
7-21
A company should measure receivables in terms of their
present value.
Non-Recognition of Interest Element
LO 4 Explain accounting issues related to recognition of accounts receivable.
In practice, companies ignore
interest revenue related to accounts
receivable because the discount is
not
usually material in relation to the
net income for the period.
Recognition of Accounts ReceivablesRecognition of Accounts Receivables
7-22
How are these accounts presented on the Balance Sheet?
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 500 25 End.
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-23
Current Assets:
Cash 330$
Accounts receivable 500
Less: Allowance for doubtful accounts (25) 475
Inventory 812
Prepaid expense 40
Total current assets 1,657
Balance Sheet (partial)
ABC Corporation
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-24
Current Assets:
Cash 330$
Accounts receivable, net of $25 allowance 475
Inventory 812
Prepaid expense 40
Total current assets 1,657
Balance Sheet (partial)
ABC CorporationAlternate
PresentationAlternate
Presentation
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-25
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 500 25 End.
Journal entry for credit sale of $100?
Accounts Receivable 100
Sales 100
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-26
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 600 25 End.
Journal entry for credit sale of $100?
Accounts Receivable 100
Sales 100
Sale 100
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-27
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 600 25 End.
Sale 100
Collected $333 on account?
Cash 333
Accounts Receivable 333
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-28
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 267 25 End.
Sale 100
Collected $333 on account?
Cash 333
Accounts Receivable 333
333 Coll.
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-29
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 267 25 End.
Sale 100 333 Coll.
Adjustment of $15 for estimated bad debts?
Bad Debt Expense 15
Allowance for Doubtful Accounts 15
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-30
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 267 40 End.
Sale 100 333 Coll.
Adjustment of $15 for estimated bad debts?
Bad Debt Expense 15
Allowance for Doubtful Accounts 15
15 Est.
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-31
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 267 40 End.
Sale 100 333 Coll.
15 Est.
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts 10
Accounts Receivable 10
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-32
Accounts ReceivableAllowance for
Doubtful Accounts
Beg. 500 25 Beg.
End. 257 30 End.
Sale 100 333 Coll.
15 Est.
Write-off of uncollectible accounts for $10?
Allowance for Doubtful accounts 10
Accounts Receivable 10
W/O 10 10 W/O
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-33
Current Assets:
Cash 330$
Accounts receivable, net of $30 allowance 227
Merchandise inventory 812
Prepaid expense 40
Total current assets 1,409
Balance Sheet (partial)
ABC Corporation
Accounts ReceivablesAccounts Receivables
LO 4 Explain accounting issues related to recognition of accounts receivable.
7-34
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-35 LO 5 Explain accounting issues related to valuation of accounts receivable.
Accounts ReceivableAccounts Receivable
Reporting of receivables involves
1) classification and
2) valuation on the balance sheet.
Classification involves determining the length of time each
receivable will be outstanding.
Value and report short-term receivables at net realizable
value.
Valuation of Accounts Receivable
7-36 LO 5 Explain accounting issues related to valuation of accounts receivable.
Valuation of Accounts ReceivableValuation of Accounts Receivable
Record credit losses as debits to Bad Debt Expense (or
Uncollectible Accounts Expense).
Normal and necessary risk of doing business on credit.
Two methods to account for uncollectible accounts:
1) the direct write-off method and
2) the allowance method.
Uncollectible Accounts Receivable
7-37 LO 5 Explain accounting issues related to valuation of accounts receivable.
Allowance Method
Losses are estimated:
Percentage-of-sales.
Percentage-of-receivables.
GAAP requires when material in amount.
Methods of Accounting for Uncollectible Accounts
Direct Write-Off
Theoretically deficient:
No matching.
Receivable not stated at cash realizable value.
Not GAAP when material in amount.
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-38 LO 5 Explain accounting issues related to valuation of accounts receivable.
Illustration 7-6
Valuation of Accounts ReceivableValuation of Accounts Receivable
The percentage-of-sales basis results in a better matching of
expenses with revenues
The percentage-of-sales basis results in a better matching of
expenses with revenues
The percentage-of-receivablesbasis produces the better estimate of
net realizable value
The percentage-of-receivablesbasis produces the better estimate of
net realizable value
7-39 LO 5 Explain accounting issues related to valuation of accounts receivable.
Percentage-of-Sales Approach
Percentage based upon past experience and anticipate
credit policy.
Achieves better matching of expenses with revenues.
Any balance in Allowance for Doubtful Accounts is
ignored.
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-40 LO 5
Illustration: Gonzalez Company estimates that about 1% of net
credit sales become uncollectible. If net credit sales for are
$800,000 for the year, it records bad debt expense as follows.
Bad Debt Expense 8,000
Allowance for Doubtful Accounts 8,000
Illustration 7-7
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-41 LO 5 Explain accounting issues related to valuation of accounts receivable.
Percentage-of-Receivables Approach
Not matching.
Reports estimate of receivables at realizable value.
Companies may apply this method using
one composite rate, or
an aging schedule using different rates.
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-42 LO 5 Explain accounting issues related to valuation of accounts receivable.
Bad Debt Expense 37,650
Allowance for Doubtful Accounts 37,650
What entry would Wilson
make assuming that the
allowance account had a zero balance?
Illustration 7-8Accounts Receivable Aging Schedule
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-43 LO 5 Explain accounting issues related to valuation of accounts receivable.
Bad Debt Expense ($37,650 – $800) 36,850
Allowance for Doubtful Accounts 36,850
What entry would Wilson
make assuming the allowance account had a credit balance of $800 before
adjustment?
Illustration 7-8Accounts Receivable Aging Schedule
Valuation of Accounts ReceivableValuation of Accounts Receivable
7-44
Valuation of Accounts ReceivableValuation of Accounts Receivable
LO 5 Explain accounting issues related to valuation of accounts receivable.
Illustration: Sandel Company reports the following financial
information before adjustments.
Instructions: Prepare the journal entry to record bad debt
expense assuming Sandel Company estimates bad debts
at (a) 1% of net sales and (b) 5% of accounts receivable.
7-45
Valuation of Accounts ReceivableValuation of Accounts Receivable
LO 5LO 5
Bad Debt Expense 7,500
Allowance for Doubtful Accounts 7,500($800,000 – $50,000) x 1% = $7,500
LO 5
Illustration: Sandel Company reports the following financial
information before adjustments.
Instructions: Prepare the journal entry assuming Sandel
estimates bad debts at (b) 1% of net sales.
7-46
Valuation of Accounts ReceivableValuation of Accounts Receivable
LO 5LO 5
Instructions: Prepare the journal entry assuming Sandel
estimates bad debts at (b) 5% of accounts receivable.
Bad Debt Expense 6,000
Allowance for Doubtful Accounts 6,000($160,000 x 5%) – $2,000) = $6,000
LO 5
Illustration: Sandel Company reports the following financial
information before adjustments.
7-47
Illustration: The financial vice president of Brown Furniture
authorizes a write-off of the $1,000 balance owed by Randall Co. in
March 1. The entry to record the write-off is:
Allowance for Doubtful Accounts 1,000
Accounts Receivable1,000
Assume that on July 1, Randall Co. pays the $1,000 amount that
Brown had written off on March 1. These are the entries:
Accounts Receivable 1,000Allowance for Doubtful Accounts
1,000
Cash 1,000Accounts Receivable
1,000
Write-Off of Uncollectible AccountsWrite-Off of Uncollectible Accounts
LO 5
7-48
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-49
Notes ReceivableNotes Receivable
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Supported by a formal promissory note.
Written promise to pay a certain sum of money at a specific
future date.
A negotiable instrument.
Maker signs in favor of a Payee.
Interest-bearing (has a stated rate of interest) OR
Zero-interest-bearing (interest included in face amount).
7-50
Notes ReceivableNotes Receivable
Generally originate from:
Customers who need to extend payment period of an
outstanding receivable.
High-risk or new customers.
Loans to employees and subsidiaries.
Sales of property, plant, and equipment.
Lending transactions (majority of notes).
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-51
Recognition of Notes ReceivableRecognition of Notes Receivable
Short-Term Long-Term
Record at Face Value,
less allowance
Record at Present Value
of cash expected to be collected
Interest Rates
Stated rate = Market rate
Stated rate > Market rate
Stated rate < Market rate
Note Issued at
Face Value
Premium
Discount
LO 6
7-52
Illustration: Bigelow Corp. lends Scandinavian Imports $10,000 in exchange for a $10,000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note?
Note Issued at Face ValueNote Issued at Face Value
0 1 2 3
1,000 1,000 Interest$1,000
$10,000 Principal
4
i = 10%
n = 3
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-53
$1,000 x 2.48685 = $2,487
Interest Received Factor Present Value
Note Issued at Face ValueNote Issued at Face Value
PV of Interest
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-54
$10,000 x .75132 = $7,513
Principal Factor Present Value
Note Issued at Face ValueNote Issued at Face Value
PV of Principal
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-55
Summary Present value of interest $ 2,487
Present value of principal 7,513
Note current market value $10,000
Note Issued at Face ValueNote Issued at Face Value
Notes Receivable 10,000Cash
10,000
Cash 1,000Interest Revenue
1,000
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Jan. yr. 1
Dec. yr. 1
Journal Entries
7-56
Illustration: Jeremiah Company receives a three-year, $10,000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note?
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
0 1 2 3
$0 $0 Interest$0
$10,000 Principal
4
i = 9%
n = 3
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-57
$10,000 x .77218 = $7,721.80
Principal Factor Present Value
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
PV of Principal
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-58
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
Illustration 7-12
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-59
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
Illustration 7-12
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Notes Receivable 10,000.00
Discount on Notes Receivable2,278.20
Prepare the
journal entry to
record the receipt
of the note.
Cash 7,721.80
7-60
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
Illustration 7-12
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Prepare the
journal entry to
record interest
revenue at the
end of the first
year.
Discount on Notes Receivable 694.96
Interest Revenue694.96
7-61
Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10,000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. Prepare the journal entry to record the receipt of the note?
Interest-Bearing NoteInterest-Bearing Note
0 1 2 3
1,000 1,000 Interest$1,000
$10,000 Principal
4
i = 12%
n = 3
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-62
$1,000 x 2.40183 = $2,402
Interest Received Factor Present Value
Interest-Bearing NoteInterest-Bearing Note
PV of Interest
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-63
$10,000 x .71178 = $7,118
Principal Factor Present Value
Interest-Bearing NoteInterest-Bearing Note
PV of Principal
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-64
Illustration: Record the receipt of the note?
Interest-Bearing NoteInterest-Bearing Note
Illustration 7-14
Notes Receivable 10,000
Discount on Notes Receivable
480
Cash
9,520LO 6 Explain accounting issues related to recognition
and valuation of notes receivable.
7-65
Interest-Bearing NoteInterest-Bearing Note
Illustration 7-15
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-66
Zero-Interest-Bearing NoteZero-Interest-Bearing Note
Illustration 7-15
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
Cash 1,000
Discount on Notes Receivable 142
Interest Revenue 1,142
Prepare the journal
entry to record
interest revenue at
the end of the first
year.
7-67
Recognition of Notes ReceivableRecognition of Notes Receivable
Notes Received for Property, Goods, or Services
In a bargained transaction entered into at arm’s length, the
stated interest rate is presumed to be fair unless:
1. No interest rate is stated, or
2. Stated interest rate is unreasonable, or
3. Face amount of the note is materially different from the
current cash sales price.
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-68
Recognition of Notes ReceivableRecognition of Notes Receivable
Illustration: Oasis Development Co. sold a corner lot to Rusty
Pelican as a restaurant site. Oasis accepted in exchange a five-year
note having a maturity value of $35,247 and no stated interest rate.
The land originally cost Oasis $14,000. At the date of sale the land
had a fair market value of $20,000. Oasis uses the fair market value
of the land, $20,000, as the present value of the note. Oasis
therefore records the sale as:
Notes Receivable 35,247
Discount on Notes Receivable
15,247
Land
14,000
Gain on Disposal of Land
6,000
($35,247 - $20,000) = $15,247
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-69
Notes ReceivableNotes Receivable
Short-Term reported at net realizable value (same as
accounting for accounts receivable).
Long-Term - FASB requires companies disclose not
only their cost but also their fair value in the notes to the
financial statements.
Valuation of Notes Receivable
LO 6 Explain accounting issues related to recognition and valuation of notes receivable.
7-70
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-71
Special IssuesSpecial Issues
Companies have the option to use fair value as the basis
of measurement in the financial statements.
If companies choose the fair value option
► Receivables are recorded at fair value.
► Unrealized holding gains or losses reported as part of
net income.
Company reports the receivable at fair value each
reporting date.
Fair Value Option
LO 7 Explain the fair value option.
7-72
Special IssuesSpecial Issues
Companies may elect at time the financial instrument is
► originally recognized or
► when some event triggers a new basis of accounting.
Must continue to use fair value measurement for the specific
instrument until the company no longer owns this
instrument.
If not elected at date of recognition, company may never
use fair value option on that specific instrument.
Fair Value Option
LO 7 Explain the fair value option.
7-73
Valuation of Notes ReceivableValuation of Notes Receivable
LO 7 Explain the fair value option.
Illustration: Escobar Company has notes receivable that have a
fair value of $810,000 and a carrying amount of $620,000. Escobar
decides on December 31, of the current year, to use the fair value
option for these receivables. This is the first valuation of these
recently acquired receivables. At December 31, Escobar makes an
adjusting entry to record the increase in value of Notes Receivable
and to record the unrealized holding gain, as follows.
Notes Receivable 190,000
Unrealized Holding Gain or Loss—Income 190,000
7-74
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-75
Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable
Owner may transfer accounts or notes receivables to
another company for cash. Reasons:
Competition.
Sell receivables because money is tight.
Billing and collection are time-consuming and costly.
Transfer accomplished by:
Secured borrowing.
Sale of receivables.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
7-76
Secured Borrowing
Illustration: March 1, 2014, Howat Mills, Inc. provides
(assigns) $700,000 of its accounts receivable to Citizens Bank
as collateral for a $500,000 note. Howat Mills continues to
collect the accounts receivable; the account debtors are not
notified of the arrangement. Citizens Bank assesses a finance
charge of 1 percent of the accounts receivable and interest on
the note of 12 percent. Howat Mills makes monthly payments to
the bank for all cash it collects on the receivables.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable
7-77 LO 8
Secured BorrowingIllustration 7-16
7-78
Illustration: On April 1, 2014, Prince Company assigns $500,000 of its
accounts receivable to the Third National Bank as collateral for a $300,000
loan due July 1, 2014. The assignment agreement calls for Prince Company
to continue to collect the receivables. Third National Bank assesses a
finance charge of 2% of the accounts receivable, and interest on the loan is
10% (a realistic rate of interest for a note of this type).
Secured BorrowingSecured Borrowing
Instructions:
a) Prepare the April 1, 2014, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000 of the accounts receivable during the period from April 1, 2014, through June 30, 2014.
c) On July 1, 2014, Prince paid Third National all that was due from the loan it secured on April 1, 2014.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
7-79
Instructions:
a) Prepare the April 1, 2014, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000.
c) On July 1, 2014, Prince paid Third National all that was.
Secured BorrowingSecured Borrowing
Cash 290,000
Finance Charge ($500,000 x 2%) 10,000
Notes Payable
300,000
a)
Cash 350,000
Accounts Receivable
350,000
b)
Notes Payable 300,000
Interest Expense (10% x $300,000 x 3/12) 7,500
Cash
307,500
c)
LO 8
7-80
Sale Without Recourse
Purchaser assumes risk of collection.
Transfer is outright sale of receivable.
Seller records loss on sale.
Sale With Recourse
Seller guarantees payment to purchaser.
Financial components approach used to record transfer.
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
Disposition of Accounts and Notes ReceivableDisposition of Accounts and Notes Receivable
Sales of Receivables
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Factors are finance companies or banks that buy receivables
from businesses for a fee.
Sales of ReceivablesSales of Receivables
Illustration 7-17
LO 8
7-82
Sales of ReceivablesSales of Receivables
Illustration: Crest Textiles, Inc. factors $500,000 of accounts
receivable with Commercial Factors, Inc., on a without recourse
basis. Commercial Factors assesses a finance charge of 3 percent of
the amount of accounts receivable and retains an amount equal to 5
percent of the accounts receivable (for probable adjustments). Crest
Textiles and Commercial Factors make the following journal entries
for the receivables transferred without recourse.
Illustration 7-18
LO 8 Explain accounting issues related to disposition of accounts and notes receivable.
7-83
Illustration: Assume Crest Textiles sold the receivables on a with
recourse basis. Crest Textiles determines that this recourse
obligation has a fair value of $6,000. To determine the loss on the
sale of the receivables, Crest Textiles computes the net proceeds
from the sale as follows.
Sales of ReceivablesSales of Receivables
Illustration 7-20Loss on Sale Computation
Illustration 7-19Net ProceedsComputation
LO 8
7-84
Illustration: Prepare the journal entries for both Crest Textiles and
Commercial Factors for the receivables sold with recourse.
Sales of ReceivablesSales of Receivables
Cash 460,000
Due from Factor 25,000
Loss on Sale of Receivables 21,000
Accounts (Notes) Receivable
500,000
Recourse Liability
6,000Accounts Receivable 500,000
Due to Customer (Crest Textiles)
25,000
Interest Revenue
15,000
Cash
460,000
Commercial Factors, Inc.
Crest Textiles, Inc.
LO 8
7-85
The FASB concluded
that a sale occurs
only if the seller
surrenders control of
the receivables to the
buyer.
Three conditions
must be met.
Secured Borrowing versus SaleSecured Borrowing versus Sale
Illustration 7-22
LO 8
7-86
6. Explain accounting issues related to recognition and valuation of notes receivable.
7. Explain the fair value option.
8. Explain accounting issues related to disposition of accounts and notes receivable.
9. Describe how to report and analyze receivables.
After studying this chapter, you should be able to:
Cash and Receivables7LEARNING OBJECTIVESLEARNING OBJECTIVES
1. Identify items considered cash.
2. Indicate how to report cash and related items.
3. Define receivables and identify the different types of receivables.
4. Explain accounting issues related to recognition of accounts receivable.
5. Explain accounting issues related to valuation of accounts receivable.
7-87
1. Segregate the different types of receivables that a company
possesses, if material.
2. Appropriately offset the valuation accounts against the proper
receivable accounts.
3. Determine that receivables classified in the current assets section
will be converted into cash within the year or the operating cycle,
whichever is longer.
4. Disclose any loss contingencies that exist on the receivables.
5. Disclose any receivables designated or pledged as collateral.
6. Disclose the nature of credit risk inherent in the receivables.
Presentation and AnalysisPresentation and Analysis
LO 9 Describe how to report and analyze receivables.
Presentation of Receivables
7-88
Analysis of Receivables
Presentation and AnalysisPresentation and Analysis
Accounts Receivable Turnover Ratio:
Use to evaluate the liquidity of accounts receivable.
Measures the number of times, on average, a company
collects receivables during the period.
Illustration 7-24
LO 9 Describe how to report and analyze receivables.
7-89 LO 10 Explain common techniques employed to control cash.
Management faces two problems in accounting for cash
transactions:
1. Establish proper controls to prevent any unauthorized
transactions by officers or employees.
2. Provide information necessary to properly manage cash on
hand and cash transactions.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-90 LO 10 Explain common techniques employed to control cash.
To obtain desired control objectives, a company can vary the
number and location of banks and the types of accounts.
General checking account
Collection float.
Lockbox accounts
Imprest bank accounts
Using Bank Accounts
APPENDIXAPPENDIX 7A CASH CONTROLS
7-91 LO 10 Explain common techniques employed to control cash.
To pay small amounts for miscellaneous expenses.
The Imprest Petty Cash System
Steps:
1. Record $300 transfer of funds to petty cash:
Petty Cash 300
Cash 300
2. The petty cash custodian obtains signed receipts from each individual to whom he or she pays cash.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-92
Steps:
LO 10 Explain common techniques employed to control cash.
The Imprest Petty Cash System
Supplies Expense 42
Postage Expense 53
Miscellaneous Expense 76
Cash Over and Short 2
Cash 173
3. Custodian receives a company check to replenish the fund.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-93
Steps:
LO 10 Explain common techniques employed to control cash.
The Imprest Petty Cash System
Cash 50
Petty cash 50
4. If the company decides that the amount of cash in the petty cash fund is excessive by $50, it lowers the fund balance as follows.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-94 LO 10 Explain common techniques employed to control cash.
Physical Protection of Cash Balances
Company should
Minimize the cash on hand.
Only have on hand petty cash and current day’s receipts.
Keep funds in a vault, safe, or locked cash drawer.
Transmit each day’s receipts to the bank as soon as
practicable.
Periodically prove (reconcile) the balance shown in the general
ledger.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-95 LO 10 Explain common techniques employed to control cash.
Reconciliation of Bank Balances
Schedule explaining any differences between the bank’s
and the company’s records of cash.
Reconciling Items:
1. Deposits in transit.
2. Outstanding checks.
3. Bank charges and credits.
4. Bank or Depositor errors.
Time Lags
APPENDIXAPPENDIX 7A CASH CONTROLS
7-96 LO 10 Explain common techniques employed to control cash.
Reconciliation of Bank Balances Illustration 7A-1Bank Reconciliation Form and Content
APPENDIXAPPENDIX 7A CASH CONTROLS
7-97 LO 10
APPENDIXAPPENDIX 7A CASH CONTROLS
7-98
Illustration 7A-2
APPENDIXAPPENDIX 7A CASH CONTROLS
Advance slide in presentation mode to reveal answer.
7-99
Cash 542Nov. 30
Office Expense 18
Accounts Receivable 220
Accounts Payable
180Interest Revenue
600
Illustration: Journalize the adjusting entry on the books of
Nugget Mining Company.
LO 10 Explain common techniques employed to control cash.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-100
The reconciling item in a bank reconciliation that will result
in an adjusting entry by the depositor is:
a. outstanding checks.
b. deposit in transit.
c. a bank error.
d. bank service charges.
Question
LO 10 Explain common techniques employed to control cash.
APPENDIXAPPENDIX 7A CASH CONTROLS
7-101
APPENDIXAPPENDIX 7B7B IMPAIRMENT OF RECEIVABLES
LO 11 Describe the accounting for a loan impairment.
Companies evaluate their receivables to determine their
ultimate collectibility.
Allowance method is appropriate when:
probable that an asset has been impaired and
amount of the loss can be reasonably estimated.
Long-term receivables such as loans that are identified as
impaired, companies perform an additional impairment
evaluation.
7-102 LO 11 Describe the accounting for a loan impairment.
Impairment Measurement and Reporting
Impairment loss is calculated as the difference between
the investment in the loan (generally the principal plus
accrued interest) and
the expected future cash flows discounted at the loan’s
historical effective-interest rate.
APPENDIXAPPENDIX 7B IMPAIRMENT OF RECEIVABLES
7-103 LO 11 Describe the accounting for a loan impairment.
Illustration: At December 31, 2013, Ogden Bank recorded an
investment of $100,000 in a loan to Carl King. The loan has an
historical effective-interest rate of 10 percent, the principal is due in full
at maturity in three years, and interest is due annually. The loan officer
performs a review of the loan’s expected future cash flow and utilizes
the present value method for measuring the required impairment loss.
Illustration 7B-1
APPENDIXAPPENDIX 7B IMPAIRMENT OF RECEIVABLES
7-104 LO 11 Describe the accounting for a loan impairment.
Illustration 7B-2
Recording Impairment Loss
Bad Debt Expense 12,434
Allowance for Doubtful Accounts 12,434
APPENDIXAPPENDIX 7B IMPAIRMENT OF RECEIVABLES
Illustration: Computation of impairment loss.
7-105
Floyd Norris, noted financial writer for the New York Times, recently wrote in his blog that he attended a conference to discuss the financial crisis in subprime lending. He highlighted, and provided “translations” of, some of the statements he heard at that conference:
• “There is a problem of misaligned incentives.”
Translation: Many parties in the lending process were complicit in not performing due diligence on loans because there were lots of fees to be had if the loans were made, good loans or bad.
• “It is pretty clear that there was a failure in some key assumptions that were supporting our analytics and our models.”
Translation: The rating agencies that evaluated the risk level of these securities made many miscalculations. Some structured finance products that were given superior ratings are no longer worth much.
• “The plumbing of the U.S. economy has been deeply damaged. It is a long window of vulnerability.”
WHAT’S YOUR PRINCIPLELOST IN TRANSLATION
Translation: The U.S. has caused a financial crisis as a result of poor lending practices, and many financial institutions are fighting to survive.
• “I’m glad that this time we did not cause it.”
Translation: Other countries realized they had caused financial crises in the past but were not to blame for the current U.S. financial situation.
• “What you see is what you get. If you don’t see it, it will get you.”
Translation: A large number of financial institutions have to take losses on assets that are not reported on their balance sheet. Their continuing interest in some of the loans that they supposedly sold is now coming back to them and they will have to report losses.
Source: Floyd Norris blog, http://www.norris.blogs.nytimes.com/
(accessed June 2008).
LO 11
7-106
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Similarities
The accounting and reporting related to cash is essentially the same under both IFRS and GAAP. In addition, the definition used for cash equivalents is the same.
Like GAAP, cash and receivables are generally reported in the current assets section of the balance sheet under IFRS.
Similar to GAAP, IFRS requires that loans and receivables be accounted for at amortized cost, adjusted for allowances for doubtful accounts.
7-107
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
Under IFRS, companies may report cash and receivables as the last items in current assets under IFRS. Under GAAP, these items are reported in order of liquidity.
While IFRS implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. GAAP has explicit guidance in the area.
The fair value option is similar under GAAP and IFRS but not identical. The international standard related to the fair value option is subject to certain qualifying criteria not in the U.S. standard. In addition, there is some difference in the financial instruments covered.
7-108
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
RELEVANT FACTS - Differences
Under IFRS, bank overdrafts are generally reported as cash. Under GAAP, such balances are reported as liabilities.
IFRS and GAAP differ in the criteria used to account for transfers of receivables. IFRS is a combination of an approach focused on risks and rewards and loss of control. GAAP uses loss of control as the primary criterion. In addition, IFRS generally permits partial transfers; GAAP does not.
7-109
ON THE HORIZON
Both the IASB and the FASB have indicated that they believe that financial statements would be more transparent and understandable if companies recorded and reported all financial instruments at fair value. That said, in IFRS 9, which was issued in 2009, the IASB created a split model, where some financial instruments are recorded at fair value but other financial assets, such as loans and receivables, can be accounted for at amortized cost if certain criteria are met. Critics say that this can result in two companies with identical securities accounting for those securities in different ways. A proposal by the FASB would require that nearly all financial instruments, including loans and receivables, be accounted for at fair value. It has been suggested that IFRS 9 will likely be changed or replaced as the FASB and IASB continue to deliberate the best treatment for financial instruments. In fact, one member of the IASB said that companies should ignore IFRS 9 and continue to report under the old standard, because in his opinion, it is extremely likely that it would be changed before the mandatory adoption date of this standard in 2013.
LO 12
7-110
Under IFRS, receivables are to be reported on the balance sheet at:
a. amortized cost.
b. amortized cost adjusted for estimated loss provisions.
c. historical cost.
d. replacement cost.
IFRS SELF-TEST QUESTION
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
7-111
Which of the following statements is false?
a. Receivables include equity securities purchased by the
company.
b. Receivables include credit card receivables.
c. Receivables include amounts owed by employees as result of
company loans to employees.
d. Receivables include amounts resulting from transactions with
customers.
IFRS SELF-TEST QUESTION
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
7-112
Under IFRS:
a. the entry to record estimated uncollected accounts is the same
as GAAP.
b. loans and receivables should only be tested for impairment as a
group.
c. it is always acceptable to use the direct write-off method.
d. all financial instruments are recorded at fair value.
IFRS SELF-TEST QUESTION
LO 12 Compare the accounting procedures for cash and receivables under GAAP and IFRS.
7-113
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