2.2 Receivables Flashcards
Why is the Direct Write-off method not consistent with GAAP?
Because not MATCHING expense at time of sale and it is not CONSERVATIVE as A/R is carried at its full face/gross amount
What method for calculating bad debt expense results in better matching?
Income statement method (% of sales approach)
What method for calculating bad debt expense results in better asset valuation?
Balance sheet method (% of receivables approach)
Does writing off of receivables have an effect on their Net Realizable Value?
No, it has no effect on receivables’ NRV.
How might a company generate cash from receivables before collecting cash from the customer?
1) Pledging
2) Assigning
3a) Factoring (sale with recourse)
3b) Factoring (sale without recourse)
4) Discounting (used for longer term)
What is meant by pledging a receivable?
- Offering (“pledging”) the receivable asset to the lender as collateral to secure the loan.
- less formal than assigning b/c no specific accounts ID
- When this occurs, it must be adequately disclosed in a footnote in the financial statements.
What is meant by assigning a receivable?
- Borrowing cash from a lender in exchange for agreeing to used the proceeds from a specific receivable asset to repay the lender.
- Sometimes, the customer is notified to make payment directly to the lender instead of the client.
- borrower reclassifiesthe receivable
- accounts receivable assigned
What is meant by factoring without recourse?
and Journal Entry
- Selling a receivable asset to another party (the factor),
- with the buyer assuming the risk that the receivable may not be collectible.
- This usually involves a “premium” that the seller “pays” in the form of receiving less of a cash payment.
(dr) Cash
(dr) Receivable from Factor (hold back % for sales returns)
(dr) Loss on Sale of AR (factoring fee)
(cr) Accounts Receivable
What is meant by factoring with recourse?
and Journal Entry
- Selling a receivable to another party (the factor),
- with the buyer retaining the right to demand that the client make good on the receivable if the customer does not pay as promised.
- Given the “recourse” that the buyer has, there is less of a premium that the seller “pays” and, as such, receives a higher amount of a cash payment relative to a similar transaction without recourse.
(dr) Cash
(dr) Loss on Sale of AR (factor fee: incl recourse L)
(cr) Recourse Liability (% held for bad debts)
(cr) Accounts Receivable (total amt)
Which factoring method would generally, all things being equal, result in a greater amount of cash up front?
Factoring with recourse
Which factoring method results in writing off the receivable?
Factoring without recourse
b/c treated as sale
Which factoring method results in keeping the liability and creating a separate liability?
Factoring with recourse
When pledging or assigning receivables, does the firm remain the legal owner of the financial asset?
Yes
When pledging or assigning receivables, what journal entry records the receipt of cash?
Dr. Cash Cr. Note payable
What journal entry would be used to assign receivables?
Dr. A/R - Assigned Cr. A/R *This is in addition to the main (Dr. Cash; Cr. Note Payable) journal entry to record the proceeds from the borrowing.
When discounting a note receivable, how is the maturity value determined?
Calculate the interest amount (face x interest rate x term) and add to the face amount
When discounting a note receivable, does the discount apply to the face amount or the maturity value?
It applies to the maturity value
What value are receivables that occur in the ordinary course of business (A/R) recorded at?
Face Value
What value are receivables (Note Rec) that DO NOT occur in the ordinary course of business (Long-Term) recorded at?
Present Value (time value of money applies)
required by GAAP
exception: notes < 1yr
What is a notes receivable?
Often related to non-customer transactions although many larger consumer items and transactions between businesses require a promissory note
- more formal financial instrument than AR
- valuation at PV
- typically from sale of PPE, conversion of AR, lending transactions
What are the 4 types of receivables?
-
Accounts receivable:
- related to customer transactions,
- short length 30-90d,
- no interest element
- Trade receivable= accounts rec
-
Notes receivable:
- noncustomer (ex: sale of noncash A, lending transactions, conversion of other rec),
- longer time than AR
- interest element
- Nontrade receivable = noncustomer transactions
What is a trade receivable?
another name for customer accounts receivable
What is a non-trade receivable?
Those receivables created in non-customer transactions
Accounts Receivable
- valuation
- factors affecting valuation (general)
- Valued at net realizable value, NRV = amt cash expect to collect at due date or maturity
- on BS: AR less allowance for uncollectible amounts
5 factors
- trade (quantity) discounts;
- cash (sales) discounts;
- sales returns and allowances;
- non-collectible accounts.
- freight charges FOB shipping/destination
What are the two methods of accounting for receivables?
The gross method (before discount) and the net method (after discount)
Who is the maker of a note?
- The buyer or borrower
- This party is making an unconditional promise to pay principal and interest over the note term
Who is the holder of a note?
- The holder of the note (seller or lender)
- is the creditor and is the firm recording the note receivable on its books.
How are notes recorded?
at Present Value unless its less than a year term
Trade (quantity) discount
- offered for high volume/quantity
-
Chain discount: get multiple discounts
- calculate = value * (1-x) * (1-y)
Cash (sales) discounts
-
contra account to sales, for early payment (failure to take is like interest)
- Sales discounts forfeited: misc Rev account, used in net method
- Allowance for sales discounts: contra to AR, adjusting entry for end of period, reduces both net sales and net acc rec
Sales returns and allowances
-
Sales returns and allowances: contra account to sales
- Returns: merchandise returned from customer
- Allowance: price reductions of merchandise
- Allowance for sales returns and allowances: contra to AR, adjusting entry for end of period when sales transactions aren’t completed
Accounts Receivable
2 methods in recording
- Gross method: record rec at gross invoice price (before cash discounts)
- Net method: record rec at net invoice price (after cash discount)
Accounts Receivable
Journal entries
(both Gross + Net)
Original recognition of Sale (trade discounts in both)
(dr) Accounts Receivable
(cr) Sales
- Gross method: full value
- Net Method: decreased for sales discount
Payment rec’d w/in discount period
-
Gross - decrease cash rec’d by amount of discount
(dr) Cash
(dr) Sales Discount
(cr) Accounts Receivable -
Net - discount already incorporated in A/R
(dr) Cash
(cr) Accounts Receivable
Payment rec’d outside discount period
-
Gross - no adjustment for discount NOT taken
(dr) Cash
(cr) Accounts Receivable -
Net - record forfeit of discount
(dr) Cash
(cr) Accounts Receivable
(cr) Sales Discounts Forfeited
Returns and allowances
(dr) Sales Returns and Allowances
(cr) Accounts Receivable
- Gross method: full value
- Net Method: decreased for sales discount
Adjusting Entry for Estimated Sales Discounts (end yr)
(dr) Sales Discounts
(cr) Allowance for Sales Discounts
-
Gross method only
- estimate amount of discounts taken by customers
Contra- accounts
- accounts receivable
- sales
- other
Accounts Receivable
Allowance for Sales Discounts
- GROSS method
- end-yr adj: estimated discounts next yr
Sales (cr)
Sales Discounts (dr)
- used in GROSS method
- payment w/in discount window
- end-yr adj: estimated discounts next yr
Sales Returns and Allowances (dr)
- used in BOTH
Other
Sales Discounts Forfeited (dr)
- NET method
- misc Revenue account
Accounts Receivable
Gross v Net Method
(general)
Gross Method
- Records original sale at full price
- Records sales discount if paid w/in windo
Net Method
- Record original sale with discount
- Records sales discount forfeited if paid outside window
FOB
Shipping Pt v Destination
FOB shipping point (FOB SP)
- Seller free of risk/pmt
- Buyer has risk/pmt
FOB Destination
- Seller has risk/pmt
- Buyer is free of risk/pmt
Accounts Receivable Recognition
GAAP v IFRS
- IFRS: defines Revenue from BS view, based on inflow of economic benefits from ordinary business
- AR (and Rev) can be recog if there is firm sales commitment* and *recog criteria met
- Rev and A are recogn when:
- Probable future economic benefits
- Rev can be measured reliably
- Costs can be measured reliably
- Sign risk/rewards of ownership are transferred
- Managerial involvement is not retained as to ownership or control
- May meet IFRS for recog, but not in US
- Measurement criteria for reporting AR very similar: future economic benefit of AR is analogous to NRV
Accounts Receivable
Uncollectibles
Accounts involved
I/SBad debt expense, BDE**(**uncollectible accounts expense):
- records effects of uncollectible accts
- Considered cost of doing business NOT sales adjustment
B/SAllowance for uncollectible accounts:
- contra-account to AR
Direct Write-off Method
Pros/cons
Cons: NOT considered GAAP, no basis for estimating bad debts
- Poor BS valuation: AR is overvalued
- Poor matching Rev/Exp: Rev recog from credit sale in yr 1, BDE in subsequent yr
Pros:
- Might not be materially different in effect on FS relative to allow method
- Simple and practical to use
Direct Write Off Method
Journal Entries
- uncollectible
- collection of previously written off
Account deemed uncollectible
(dr) Bad Debt Expense
(cr) Accounts Receivable
Collection of previously written off
(dr) Cash
(cr) Bad Debts Recovered
Allowance Method
- when used
- when recorded
- pros
- Used by most large firms, required under GAAP if uncollectible accts are
- probable
- estimable
- Records estimate of BDE at end of each yr adjusting entry
- Allowance (contra-AR) created reduces Net AR
- Both Income and Net AR are reduced in yr of sale by
- Pros:
- Value AR at net realizable value (NRV) on BS
- Recog Rev/Exp from credit sales in same acct year
Allowance for uncollectible accounts
2 methods to estimate
Income statement approach (% of sales)
- Estimate uncollectible AR as a % of sales
- uses prior year collection rates
- Directly calculates amt of BDE
- = Credit sales * % of sales uncoll
- Previous balance in Allow acct not considered
- GOAL: properly value IS accounts
- Sales Rev
- BDE
Balance sheet approach (% of Receivables)
- Estim uncollectible AR as % of AR balance outstanding
- Direclty calculates ending balance of allowance acct
- = AR * % of AR uncoll
- Need to find difference bet existing balance in allowance and desired balance
- GOAL to properly value BS accounts
- Net Accounts Rec
Allowance for Doubtful Accounts
Journal Entries
- end of period adjustment
- write off
- recovery of accounts
End of Period Adjustment
(dr) Bad Debt Expense
(cr) Allowance for Doubtful Accounts
Write off
(dr) Allowance for Doubtful Accounts
(cr) Accounts Receivable
Recovery of accounts previously written off
(dr) Accounts Rec
(cr) Allowance for Doubtful Accounts
(dr) Cash
(cr) Accounts Receivable
Accounts Rec + Allowance
T-accounts of use
Accounts Receivable (+A, dr)
- (dr) Beg Balance
- (dr) add: Credit Sales
- (dr) add: Reinstatements
- (cr) less: cash collections
- (cr) less: write offs
- (dr) End Balance
Allowance for uncollectible accounts (-xA, cr)
- (cr) Beg Balance
- (cr) add: BDE
- (cr) add: Reinstatements
(dr) less: write offs
* (cr) End Balance
Interest Elements in Notes Receivable
2 types
Interest-bearing note: interest element is explicitly stated
- Pay interest amt in addition to face amount of note
- Ex: 3yr, 9% NR amt collected is face amt (principle) + interest
Non-interest-bearing note (implicit interest): not explicitly stated, but rather included in face value payment at end
- purchase price is reduced to change amt interest rec
- Use PV of future cash flows to calculate interest discounting a note
- Ex: 2yr, $13K non interest bearing NR amt collected is face amt of note (ncludes both principle and interest)
Notes Receivable - Interest Stated
Journal Entries
- date of sale
- accruing interest
- collection
Date of Sale
(dr) Note Receivable (face value)
(cr) Sales
Interest Accrued
(dr) Interest Receivable
(cr) Interest Income
Collection
(dr) Cash
(cr) Interest Receivable
(cr) Note Receivable (face value)
Notes Receivable: Non-Interest Bearing
Journal Entries
- date of sale
- accruing interest
- collection
interest income brings PV to Face value
Date of Sale
(dr) Note Receivable (use PV of face value)
(cr) Sales
Interest Accrued
(dr) Note Receivable
(cr) Interest Income
Collection
(dr) Cash
(cr) Note Receivable (face value)
Note Receivable
different rates used
Discount rate** used is **market rate of interest on date of note creation
- **might be different from note’s stated rate
- Any discount rates are amortized by applying the effective interest method
Stated rate is on face of note
Note Receivable
total interest over life of loan
- interest bearing
- implicit
Interest Bearing Note
- if equal payments over life of principle and interest
- total interest revenue = total amount rec’d - PV of note
Implicit Note
- interest is the amount that increases PV (at beginning) to face value (at collection)
Note Receivable
valuation
Generally at PV
Exchanged for Cash:
- only cash
- PV at issuance = cash proceeds exchanged
- if cash and promise to provide merchandise at a discount from mkt price
- record at PV
Interest-bearing:
- PV is same as face amount of note
Non-interest bearing (or unrealistic stated rate):
- report at whichever is more determinable:
- PV
- FV of property, good, service exchanged
- Discount/premium amortized using interest method
- Calculate interest with market rate applied to carrying amount of note at beginning of period
Loan origination fees: deferred/amortized over life of loan
- an adjustment to interest income
Note Receivable
Journal entries
discount / premiums
(seller of note)
PREMIUM: stated rate < mkt rate
receive NR in exchange
(dr) Note Rec
(cr) Discount on NR
(cr) Asset
interest pmts rec’d
(dr) Cash
(dr) Discount on NR
(cr) Interest Income
rec loan principle
(dr) Cash
(cr) Note Rec
PREMIUM: stated rate > mkt rate
receive NR in exchange
(dr) Note Rec
(dr) Premium on NR
(cr) Asset
interest pmts rec’d
(dr) Cash
(cr) Premium on NR
(cr) Interest Income
rec loan principle
(dr) Cash
(cr) Note Rec
Receivables as Immediate sources of cash
3 parties involved
- Maker (customer): debtor that has borrowed funds or purchased A and provided NR to original creditor
- Original creditor**: (**transferor) furl that has loaned funds/sold A to maker
- 3rd party financial inst**: (**transferee) provides funds to original creditor
Transferring Receivables
criteria for sale
if met / not met
Meets ALL 3 conditions:
- Transferred A isolated from transferor, even in bankruptcy
- Transferee is free to pledge or exchange A
- NO agreement in which T-or will be required to repurchase the A
If all 3 conditions met –> record as a SALE
HAS continuing involvement
- remove/reclassify A
- recognized A recd, L incurred
- gain/loss recorded
NO continuing involvement
- remove A
- gain/loss recorded
If NOT met is SECURED BORROWING:
- transferor is borrowing funds AND using rec as collateral for loan
- A remains on books
- record a L
- No gain/loss on sale –> is interest expense
Transfer of NR
- recourse
- notification
Recourse: T-or responsible for nonpmt on part of original maker of rec
- (ie: orig debtor defaults, original creditor assumes all pmts on rec)
-
Without recourse: T-or NOT responsible for nonpayment
- Usually records as sales b/c control has based to T-ee
Notification: maker of rec is informed of transaction and instructed to make pmts to 3rd party
- Non-notification: maker not informed and continues to make pmts to original creditor
Discounting - transfer of AR
- sale of NOTE receivable to 3rd party
- usually with recourse
- uses a contra asset to NR
- calculations
- interest accrued prior to discounting
- proceeds to be rec’d
- discount charged by bank
- = disc rate * maturity value (P+I) *m/yr
- proceeds = maturity value - discount
- can use
- footnote disclosure: NR removed from books
- contra A: NR stays on books, use contra-account
Discounting Note Rec
Footnote method
- calculation
- JE
Accrued interest for time held NR
= face amt * stated rate * m-held/yr
Maturity Value = Face Amount + Total Interest
-
Total Interest (prorated for original term)
- = face amt * stated rate * m/yr
Proceeds from Discounting Note Rec
= Maturity Value - Discount charged by bank
- Disc by bank = maturity value * bank disc rate * remaining m/yr
Discounting of NR
(dr) Cash (= proceeds)
(dr) Interest Expense (plug = tot interest at mat - bank disc)
(cr) Interest Income (accrued amount)
(cr) Note Rec (face value, remove from books)
Default (by maker w/ recourse)
(dr) N/R Overdue (=maturity value)
(cr) Cash
Discounting Note Rec
contra asset
- calculation
- JE
Accrued interest for time held NR
= face amt * stated rate * m-held/yr
Maturity Value = Face Amount + Total Interest
-
Total Interest (prorated for original term)
- = face amt * stated rate * m/yr
Proceeds from Discounting Note Rec
= Maturity Value - Discount charged by bank
- Disc by bank = maturity value * bank disc rate * remaining m/yr
Discounting of NR
(dr) Cash (= proceeds)
(dr) Interest Expense (plug = tot interest at mat - bank disc)
(cr) Interest Income (accrued amount)
(cr) Note Rec Discounted (face value, remove from books)
Repayment of note by maker
(dr) N/R Discounted (=face value)
(cr) N/R
Default (by maker w/ recourse)
(dr) N/R Overdue (=maturity value)
(cr) Cash
(dr) N/R Discounted (=face value)
(cr) N/R
Impaired Loan (NR)
(def)
Impaired loan: present value (PV) of future cash flows expected to be collected (using original effective interest rate) < carry value (CV)
- If the FV of loan is determinable use it instead of PV
- Loss is considered bad debt expense / allowance for decline in NR (contra to receivable)
Impaired Loan (NR)
- Measurement
- Initial Recognition
Measure impaired loan w/ one of 3 methods
-
Discounted Future Cash Flow: PV of future P+I inflows (net of disposal costs)
- Discounted w/ loan’s effective interest rate
- Observable market price
- FV of collateral method: if loan is collateral dependent
Discounted Future Cash Flow method
- given agreed reduction in principle and interest rate
- Unpaid Investment (due from borrower) @ this date
= Principal (face) + unpaid interest (to date, using stated rate)
*also include any net deferred loan fees/costs* and unamort *prem/disc
- PV of Reduced Principal and interest (agreed reduction amount)
- Allowance for impaired loan
= Unpaid Investment - PV of reduced P+I
Journal Entry
(dr) bad debt expense
(cr) Allowance for Impaired Loan
Impaired Loan (NR)
Subsequent recognition of interest after impairment
2 methods
Interest method: same as for any other note or bond
- interest rev for period is based on NET note balance at BEG of period
- Int rev = new CV (impaired principle) * original int rate
Cost-recovery method:
- delays recog of interest REVENUE until entire new CV (after impairment) is received
- Int rev = 0 for each period until cumulative pmts have recovered the new CV (after impairment)
Impaired Loan (NR)
IFRS
- impairment determination
- valuation
- If CV of A > amt coult be reoverd through A use or by selling it is impaired
- IFRS more flexible in allowing reversal of impairment losses
Recoverable amount = higher of Fair Value, less cost to sell OR value in use
Value in use: discounted PV of futures cash flows expected from A
Cash generating unit (CGU): smallest group of As that can be IDd that generates cash flows, independently of cash flows from other A
