Wacky Warning Labels (from ) A warning on an electric drill made for carpenters’ cautions: “This...

Wacky Warning Labels (from www.wackywarnings.com)

• A warning on an electric drill made for carpenters’ cautions: “This product not intended for use as a dental drill”

• The label on a bottle of drain cleaner warns: “If you do not understand, or cannot read, all directions, cautions and warnings, do not use this product”

• A smoke detector warns: “Do not use the Silence Feature in emergency situations. It will not extinguish a fire.”

• A cardboard car sunshield that keeps sun off the dashboard warns, “Do not drive with sunshield in place”

• An “Aim-n-Flame” fireplace lighter cautions, “Do not use near fire, flame or sparks”

• A label on a hand-held massager advises consumers not to use “while sleeping or unconscious”

• A snowblower warns: “Do not use snowthrower on roof”

CHAPTER 7

CASH AND RECEIVABLES

Sommers – Intermediate I

Company writes a check for more than the amount in its cash account.

Bank Overdrafts

Generally reported as a current liability.

Offset against other cash accounts only when accounts

are with the same bank.

Reporting Cash

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 ReceivableAccounts Receivable Notes ReceivableNotes Receivable

Accounts Receivable

Nontrade Receivables

1. Advances to officers and employees.

2. Advances to subsidiaries.

3. Deposits to cover potential damages or losses.

4. Deposits 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 Receivable

Reductions from the list price

Not recognized in the accounting

records

Customers are billed net of discounts

Trade Discounts

Inducements for

prompt payment

Gross Method

vs. Net MethodPayment terms are 2/10, n/30

Cash (Sales) Discounts

Sales and Trade Discounts

Tracy Company, a manufacturer of air conditioners, sold 100 units to Thomas Company on November 17, 2011. The units have a list price of $600 each, but Thomas was given a 30% trade discount. The terms of the sale were 2/10, n/30.

Assume the gross method of accounting for cash discounts is used.

Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.

11/17 Accounts receivable 42,000

Sales 42,000

11/26 Cash 41,160

Sales discounts 840

Accounts receivable 42,000

Assume the gross method of accounting for cash discounts is used.

Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.

Sales 42,000

12/15 Cash 42,000

Assume the net method of accounting for cash discounts is used.

Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on November 26, 2011.

Sales 41,160

11/26 Cash 41,160

Assume the net method of accounting for cash discounts is used.

Prepare the journal entries to record the sale on November 17 (ignore cost of goods) and collection on December 15, 2011.

Sales 41,160

12/15 Cash 42,000

Interest income 840

A company should measure receivables in terms of their present value.

In practice, companies ignore interest revenue related to accounts receivable because, for current assets, the amount of the discount is not usually material in relation to the net income for the period.

Non-Recognition of Interest

How are these accounts presented on the Balance Sheet?

Accounts ReceivableAllowance for

Doubtful Accounts

Beg. 500 25 Beg.

End. 500 25 End.

Recognition of A/R

Current Assets:

Cash 346$

Accounts receivable 500

Less: Allowance for doubtful accounts (25) 475

Inventory 812

Prepaids 40

Total current assets 1,673

Fixed Assets:

Office equipment 5,679

Furniture & fixtures 6,600

Less: Accumulated depreciation (3,735)

Total fixed assets 8,544 Total Assets 10,217$

Assets

Recognition of A/R

Current Assets:

Cash 346$

Accounts receivable, net of $25 allowance 475

Inventory 812

Prepaids 40

Total current assets 1,673

Fixed Assets:

Office equipment 5,679

Furniture & fixtures 6,600

Less: Accumulated depreciation (3,735)

Total fixed assets 8,544 Total Assets 10,217$

Assets

Recognition of A/R

An uncollectible account receivable is a loss of revenue

that requires, through proper entry in the accounts,

a decrease in the asset accounts receivable and

a related decrease in income and stockholders’

equity.

Uncollectible A/R

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.

Direct Write-Off vs. Allowance Method

Emphasis on the Income Statement relations

Emphasis on the Balance Sheet relations

Percentage of Sales vs. Receivables

Percentage-of-Sales Approach

Percentage based upon past experience and

anticipate credit policy.

Achieves proper matching of costs with revenues.

Existing balance in Allowance account not considered.

Percentage of Sales Approach

Example 1a

West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year:• Accounts receivable $ 900,000• Allowance for bad debts (credit balance) 16,000• Credit sales for 2009 1,750,000

West uses the following method of estimating bad debts for 2009:• Based on 2% of credit sales.

What amount should West charge to bad debt expense at the end of 2009 under Percentage of Sales (income statement) method?

$1,750,000 * 2% = $35,000

Bad debt expense 35,000

Allowance for bad debts 35,000

Percentage-of-Receivables Approach

Not matching.

Reports receivables at realizable value.

Companies may apply this method using

one composite rate, or

an aging schedule using different rates.

Percentage-of-Receivables Approach

Example 1b

West Company had the following account balances at December 31, 2009, before recording bad debt expense for the year:• Accounts receivable $ 900,000• Allowance for bad debts (credit balance) 16,000• Credit sales for 2009 1,750,000

West uses the following method of estimating bad debts for 2009:• Based on 5% of year-end accounts receivable.

What amount should West charge to bad debt expense at the end of 2009 under Percentage of Accounts Receivable (balance sheet) method?

$900,000 * 5% = $45,000 as ending ABD balance

Allowance for bad debts 29,000 (45,000 – 16,000)

Bad Debt Expense 36,850

Allowance for Bad Debts ($37,650 – $800)36,850

What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment?

A/R Aging Adjustment

Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows:

Beginning balance $ 574,000

Credit sales 2,620,000

Collections (2,483,000)

Write-offs (68,000)

Ending balance $ 643,000

The company’s controller prepared the following aging summary of year-end accounts receivable:Age Group Amount % Uncollectible

0-60 days $430,000 4%

61-90 days 98,000 15%

91-120 days 60,000 25%

Over 120 days 55,000 40%

Totals $643,000

Prepare a summary journal entry to record the monthly bad debt accrual and the write-offs during the year.

Bad Debt ProblemDuring the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. Accounts receivable activity for 2011 was as follows:

Write-offs (68,000)

Bad debt expense (3% x $2,620,000) 78,600

Allowance for uncollectible accounts 78,600

Allowance for uncollectible accounts 68,000

Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. During the year, a monthly bad debt accrual is made by multiplying 3% times the amount of credit sales for the month. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000. Accounts receivable activity for 2011 was as follows:

Write-offs (68,000)

The company’s controller prepared the following aging summary of year-end accounts receivable: Age Group Amount % Uncollectible

0-60 days $430,000 4%

61-90 days 98,000 15%

91-120 days 60,000 25%

Over 120 days 55,000 40%

Totals $643,000

Prepare the necessary year-end adjusting entry for bad debt expense.

Bad Debt ProblemSwathmore Clothing Corporation grants its customers 30 days’ credit. The company uses the allowance method for its uncollectible accounts receivable. At the fiscal year-end of December 31, an aging of accounts receivable schedule is prepared and the allowance for uncollectible accounts is adjusted accordingly. At the end of 2010, accounts receivable were $574,000 and the allowance account had a credit balance of $54,000.

Age Group Amount % Uncollectible Allowance

0-60 days $430,000 4% $17,200

61-90 days 98,000 15% 14,700

91-120 days 60,000 25% 15,000

Over 120 days 55,000 40% 22,000

$68,900

54,000

78,600

68,000

? Solve for Bad Debt Expense

68,900

Allowance for bad debts 4,300

Bad Debt Problem

What is total bad debt expense for 2011?

Monthly accruals $78,600

Year-end adjustment 4,300

Total $82,900

How would accounts receivable appear in the 2011 balance sheet?

Current assets:

Accounts receivable, net of $68,900

allowance for uncollectible accounts $574,100

Sandel Company reports the following financial information before adjustments.

Prepare the journal entry to record bad debt expense assuming

Sandel estimates bad debts at (a) 1% of net sales.

Allowance for Doubtful Accounts 7,500($800,000 – $50,000) x 1% = $7,500

Example 2a

Sandel Company reports the following financial information before adjustments.

Prepare the journal entry to record bad debt expense assuming

Sandel estimates bad debts at (b) 5% of accounts receivable.

Allowance for Doubtful Accounts 6,000[($160,000 x 5%) – $2,000] = $6,000

Example 2b

Effect of Write-Offs

On May 6, Timberland wrote off a specific account receivable with balance of $2,500.

Assume that before the write-off entry, Timberland’s Accounts Receivable balance was $81,000,000 and the Allowance for Doubtful Accounts balance was $2,000,000. What effect did the write-off have?

Date Description Debit CreditMay 6 Allowance for Doubtful Accounts 2,500

Accounts Receivable 2,500

Before Write-Off

After Write-Off

Accounts receivable 81,000,000$ 80,997,500$ Less: Allow. for doubtful accts. 2,000,000 1,997,500 Net realizable value 79,000,000$ 79,000,000$

Assume that the financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. on March 1, 2012. The entry to record the write-off is:

Allowance for Doubtful Accounts 1,000

Accounts Receivable 1,000

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

Reversal of Write-Off

Supported by a formal promissory note.

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).

Notes 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 (the majority of notes).

Notes Receivable..

Note Receivable Journal Entries

On June 30, 2011, the Esquire Company sold some merchandise to a customer for $30,000. In payment, Esquire agreed to accept a 6% note requiring the payment of interest and principal on March 31, 2012. The 6% rate is appropriate in this situation.

Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold).

June 30, 2011

Note receivable 30,000

Sales revenue 30,000

Prepare the journal entry at December 31, 2011.

December 31, 2011

Interest receivable 900

Interest revenue 900

($30,000 x 6% x 6/12) = 900

Prepare the journal entry at March 31, 2012.

March 31, 2012

Cash 31,350

Interest receivable 900

($30,000 x 6% x 3/12) = 450

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. How does Morgan record the receipt of the note?

0 1 2 3

1,000 1,000 Interest$1,000

$10,000 Principal

i = 12%

Interest-bearing Note

FV=10,000, pmt=1,000, n=3, i=12% => PV=9,520

Illustration: How does Morgan record the receipt of the note?

Notes Receivable 10,000

Discount on Notes Receivable 480

Cash 9,520

Illustration 7-15

Journal Entries for Interest-Bearing Note

Date Account Title Debit Credit

Beg. yr. 1 Notes receivable 10,000

Discount on notes receivable 480

Cash 9,520

End. yr. 1

($9,520 x 12%)

Cash 1,000

Discount on notes receivable 142

Interest revenue 1,142

Q7-15 What is “imputed interest”?Imputed interest is the interest ascribed or attributed to a situation or circumstance which is void of a stated or otherwise appropriate interest factor. Imputed interest is the result of a process of interest rate estimation called imputation.

In what situations is it necessary to impute an interest rate for notes receivable?An interest rate is imputed for notes receivable when (1) no interest rate is stated for the transaction, or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the note is materially different from the current cash price for the same or similar items or from the current market value of the debt instrument.

Discussion Question

Q7-15 Continued – What are the considerations in imputing an appropriate rate?

In imputing an appropriate interest rate, consideration should be given to the prevailing interest rates for similar instruments of issuers with similar credit ratings, the collateral, and restrictive covenants.

Non-Interest Bearing Note

On April 30, 2011, the Rangers Company sold some merchandise to a customer for $40,000. Rangers agreed to accept a payment of $40,000 on April 30, 2016. A 6% interest rate is appropriate in this situation.

Prepare the journal entry to record the sale of merchandise (omit any entry that might be required for the cost of the goods sold).

FV=40,000, pmt=0, n=5, i=6% => PV=29,890

April 30, 2011

Discount on note receivable 10,110

Sales revenue 29,890

Prepare the amortization schedule.

Cash Interest Amort Balance4/30/2011 29,890 4/30/2012 4/30/2013 4/30/2014 4/30/2015 4/30/2016

Cash Interest Amort Balance4/30/2011 29,890

4/30/2012 -

1,793 1,793 31,683 4/30/20134/30/20144/30/20154/30/2016

4/30/2012 -

1,793 1,793 31,683

4/30/2013 -

1,901 1,901 33,584 4/30/20144/30/20154/30/2016

4/30/2012 -

1,793 1,793 31,683

4/30/2013 -

1,901 1,901 33,584

4/30/2014 -

2,015 2,015 35,599

4/30/2015 -

2,136 2,136 37,735

4/30/2016 -

2,265 2,265 40,000

December 31, 2011

(1,793 X 8/12)

4/30/2012 -

1,793 1,793 31,683

4/30/2013 -

1,901 1,901 33,584

4/30/2014 -

2,015 2,015 35,599

4/30/2015 -

2,136 2,136 37,735

4/30/2016 -

2,265 2,265 40,000

December 31, 2012

(1,793 X 4/12) + (1,901 X 8/12)

4/30/2012 -

1,793 1,793 31,683

4/30/2013 -

1,901 1,901 33,584

4/30/2014 -

2,015 2,015 35,599

4/30/2015 -

2,136 2,136 37,735

4/30/2016 -

2,265 2,265 40,000

What is the balance of the note at December 31, 2012?

31,683 + (1,901 X 8/12) = 32,950

4/30/2012 -

1,793 1,793 31,683

4/30/2013 -

1,901 1,901 33,584

4/30/2014 -

2,015 2,015 35,599

4/30/2015 -

2,136 2,136 37,735

4/30/2016 -

2,265 2,265 40,000

Prepare the journal entry at April 30, 2016.

April 30, 2016

Discount on note receivable 755

(2,265 X 4/12)

Cash 40,000

4/30/2012 -

1,793 1,793 31,683

4/30/2015 -

2,136 2,136 37,735

4/30/2016 -

2,265 2,265 40,000

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.

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 35,247Discount on Notes Receivable 15,247Land 14,000Gain on Sale of Land 6,000

($35,247 - $20,000) = $15,247

Notes Receivable Example

Discussion Question

Q7-16 What is the fair value option? Where do companies that elect the fair value option report unrealized holding gains and losses?

The fair value option gives companies the option of using fair value as the measurement basis for financial instruments. The Board believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost. If companies choose the fair value option, the receivables are recorded at fair value, with unrealized gains or losses reported as part of net income.

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.

► Fair Value Option. Companies have the option to use

fair value as the basis of measurement in the financial

statements. Adjustments to value go through net income.

Valuation of Notes Receivable

Owner may transfer accounts or notes receivables to another company for cash.

Reasons:

Competition. Sell receivables because money is tight. Billing / collection are time-consuming and costly.

Transfer accomplished by:

1. Secured borrowing

2. Sale of receivables

Disposition of Receivables

Secured borrowing• Now

Cash XXX

Payable XXX

Get cash sooner, have A/R and payable on books

• Later

Cash XXX

A/R XXX

Payable XXX

Cash XXX

Sale of Receivables• Now

Cash XXX

A/R XXX

Get cash sooner, but have nothing else on books

• Later

Nothing

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 vs. Sale

Factors are finance companies or banks that buy receivables from businesses for a fee.

Illustration 7-17

Sale of Receivables

Sale Without Recourse

Purchaser assumes risk of collection Transfer is outright sale of receivable Seller records loss on sale Seller uses Due from Factor (receivable) account to

cover discounts, returns, and allowances

Sale With Recourse Seller guarantees payment to purchaser Financial components approach used to record transfer

Sale of Receivables

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 of Receivables

Discussion Question

Q7-21 What is the accounts receivable turnover ratio, and what type of information does it provide?

The accounts receivable turnover ratio is computed by dividing net sales by average net receiv ables outstanding during the year. This ratio is used to assess the liquidity of the receivables. It measures the number of times, on average, receivables are collected during the period. It provides some indication of the quality of the receivables and how successful the company is in collecting its outstanding receivables.

This Ratio used to:

Assess the liquidity of the receivables.

Measure the number of times, on average, a company

collects receivables during the period.

A/R Turnover Ratio

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.

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.

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.

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