8. Trade Receivable Flashcards
PLEDGING is borrowing cash and using part of the AR (75%) as collateral to secure loan. Age and credit worthiness of the receivable are taken under consideration by the lender.
- Entity records the loan
- pledge disclosed in footnote on FS
- no change in control or transfer of ownership of the receivable
- entity bears the uncollectible risk
FACTORING receivable is to sell the receivable to a third party for a fee.
- company surrender control
Factoring WITH recourse -
- company retains the risk of uncollectible
- the factor (buyer) has the right to demand payment for defaulted receivable
Factoring WITHOUT resource
- factor (buyer) assumes the the risk for any uncollectible receivable
DISCOUNTING is selling AR to a bank or financial institution for a fee. Bank uses maturity value (MV) - principal plus interest due at MATURITY for the calculation of the bank’s discount (financing fee).
MV is reduced by bank’s discount rate and the remaining time from the discount date until maturity date.
Company receives the net proceeds, Maturity Value minus Discount
Example:
Roth received from customer one year $500 note bearing annual 8% interest. After holding for 6 months, Roth discounted the note at the Bank at 10% interest rate. What amount of cash did Roth received?
Interest at maturity:
principal + interest + total term
$500 x 8% x 12/12 month = $40
Maturity Value: $500 + $40 =$540.00
Bank discount:
Maturity V x discount rate x time remaining
540 x 10% x 6/12 = $27
Net cash proceeds: 540 - 27 =$513
minus bank discount
Record interest earned prior to discounting the note:
Dr Interest Receivable
Cr Interest Revenue*
*accrues interest for 6 months (500x8%x6/12)
Record discounting notes receivable (without recourse)
Dr Cash (maturity - discount)
Dr Loss on discounting Notes Rec.
Cr Note Receivable (Face Value)
Cr Interest Receivable
Accrued interest 6 months
Carrying Value of AR equals amount expected to be collected after considering credit risk.
OFF BALANCE SHEET CREDIT RISK an entity may have a risk of credit loss associated with a financial asset or liability eg. entity’s guarantee of another entity’s obligations) that is not reported on BS. Unless the obligation is unconditionally cancelable, off balance sheet credit losses are recorded as a liability. I don’t understand this very much !!!!!!
Because the AR are reported on the BS the credit risk is NOT considered off balance sheet risk.
On and off balance sheet credit risk
Financial asset or liabilities recorded on BS?
Yes - 1. record expected credit losses in allowance (contra asset) account
2. Total credit risk equals net carrying value of asset
No - 1. check for off balance sheet credit risk exposure
2. record expected credit losses as a liability
Total risk of credit loss equals $230 (250-20)*
Account Receivable- allowance for credit loss
Direct write-off and Allowance methods of credit Losses
Direct Wrote-off / Allowance
Required for: Tax reporting/ Financial reporting
Credit loss expense recognized: when acct. deemed uncollectible/ estimated at end of each period
Uses allowance of credit loss account: No/ Yes
Reported value of receivables: Gross amount/ Net Carrying value (Receivables less Allowance)
Under Direct write off method the AR is recorded at gross amount, NO Allowance of credit loss account.
Collection on AR previously written off:
AR - no effect
Allowance - Increased
The current expected credit losses model uses an Allowance for credit losses (ie. contra account to AR) to accumulate the estimated expected credit losses ie. bed debt.
On each reporting date, the allowance is adjusted so that the net carrying value of AR equals what is expected to be collected after considering credit risk.
Allowance for credit loss account
————————————————
I $55 beg bal
Write off $20 I
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I $45 subtotal
adj for credit
Loss. ??? I
$20. I
—————————————————
I $25 ($500x5%)
* 5% is an estimated uncollectible AR
$20 reversal of expenses
Entry to record:
Dr Allowance to credit losses $20
Cr Reversal of credit loss expense $20
Allowance for credit loss account
————————————————
I $42 beg bal
Write off
During the year
I $6 w/o recovered
————————————————-
I $48 subtotal bef. adj
adj for credit
Loss (PLAG) I
$11 I
—————————————————
I $37 ($740x5%)
* 5% is an estimated uncollectible AR
* $740 AR
On income statement:
Reversal of credit loss expenses
———————————————
I $11 adjustment
!!! Each reporting date the Allowance is adjusted so that the net carrying value of the receivable equals the amount expected to be collected:
*An increase (Cr) in the Allowance indicated additional credit losses and is reported as an Expense.
* A decrease (Dr ) in the allowance indicates a decline in credit losses and is reported as a reversal of the credit losses expense.
What would get to collet the AR faster?
Factoring is a transaction in which an entity sells its AR for cash to a 3rd party ie. a factor) at a discount ie. factoring fee. This method allows the entity to collect cash faster than it would be waiting the full collection period for the receivable to be paid. Factoring can be done with recourse or without recourse.
Discounting could accelerate payment but there is no guarantee because the control of the cash flows’ timing still rests with the customer. Customer with liquidity issues may not have cash available until the end of the payment period, regardless of the incentive to pay early.
Factoring receivable with and without recourse
Determining net proceeds from factoring
Gross AR
Less: factoring fee (due from factor)
Less: factor’s holdback (loss on factoring)
———————————-
Net cash proceeds $xxx
Without recourse
Dr cash $xx
Dr due from factor*
Dr loss on factoring**
Dr allowance for credit losses**
Cr Accounts receivable
loss on factoring - 4% commission on the gross amount of the factored receivables was charged
due from factor - factor retain 8% as allowance for sale returns and disputed receivables
** *the allowance for credit losses is removed and replaced by the recourse liability
With recourse
Dr cash $xx
Dr loss on factoring
Dr allowance for credit losses ^
Cr Accounts receivable
Cr estimated recourse liability ^
Even if the receivable are factored without recourse, there could be losses not related to collectibility eg. future sales returns, disputed accounts). To protect the factor, an amount is often withheld from the sale proceeds known as factor’s holdback.
To protect the factor from noncredited losses eg. future sales returns, dispute accounts), an amount known as the factor’s holdback is withheld from the sale proseeds.
when receivable sold with recourse, the Seller retains the risk of uncollectible accounts. The estimated credit losses $1,800 will be recorded as a recourse liability, this has no impact on the cash received.
AR can be used as collateral for a loan ie. secured borrowing in which the company retains ownership and the risk of uncollectible account. AR can be factored (sold) for a fee.
Estimated future sales returns are recorded at the time of the sale by debiting the right to recover goods and crediting a refund liability account.
Accrual returns during the year reduce the refund liability, no AR. The ending balance in the liability account represents the future estimated returns.
If the percentage-of-receivable method is used, the calculated uncollectible receivable represent the ending balance of the allowance for credit losses account.
To determine the cash collected from customer:
Credit sale
Deduct: writes off
Deduct: increase in AR balance
Equal: cash collected from customer
For the Note Receivable that have been discounted with recourse it is reasonably possible the customer may default. Therefore, the company is not required to record a liability but instead must disclosed in the footnote to the financial statements, the amount that might have to be paid ie. the MV) to the bank as *contingent liability *.
GAAP rules for loss contingency
Classification Chance of event Disclose/Accrue
Remote: unlikely to occur No/ No
Reasonably possible: more then remote, but less than probable Yes / No
Probable and estimable: likely to occur Yes / Yes
Probable and not estimable: likely to occur Yes / No
Discounting with recourse of $50, 8%, two year note receivable, discounted at 10% after one year.
Dr interest receivable $4
Cr interest revenue* $4
Dr Cash $52.2
Dr Loss on discounting Note Receivable $1.8
Cr note receivable discounted(FV) $50
Cr Interest receivable $4
*accrued interest for 1 year $50x8%
Face amount (principal) of NR $50
+ interest at maturity 50x8%x2y $8
Maturity value $58
- bank discount 58x10%x1y $5.8
Net cash proceeds $52.2
On each reporting date, the Allowance is adjusted so the net carrying value of AR equals what is expected to be collected. The allowance for credit losses at year end is the difference between the AR and the net carrying value of AR.
In the question they asked for what amount should company report as the allowance for credit loss?
Just need to get AR end bal - $ expected to collect.
GAAP requires the current expected credit loss (CECL) model to be used when accounting for credit losses ie. bad debts). Instead reducing the AR directly, expected credit losses accumulate in the Allowance for credit losses, a contra asset account.
Each reporting date, the Allowance account is adjusted so the net carrying value of AR equals what is expected to be collected based on the estimated credit risk.
When there is an allowance for credit losses in the question, make sure not to account for it when calculating AR ! ! !*
Account Receivable
Dr Beginig balance
Dr Credit Sale
Dr Reinstatement of accounts written off
Ending Balance
Cr Collectuons
Cr Recoveries
Cr Write off of accounts deems uncollectible
Ending balance
Journal for reinstatement of receivable and subsequent collection
First reinstate previously written off balance
Dr AR
Cr Allowance for credit losses
Then record the collection of the previously written off account:
Dr Cash
Cr AR
The direct writ off method is not allowed under GAAP bc violates In two ways:
1. Not matching: credit loss ie. bed debt, expenses is not recorded at the time of sale
2. Not conservative: AR is carried at its face amount, which will overstate the AR balance on the balance sheet.
The Allowance model or the current expected credit loss model must be used for GAAP purposes.
Allowance for Credit Losses
Dr Account written off
Cr Beg Balance
Cr Accounts recovered
Cr Credit loss expense
Ending balance - expected uncollectible portion of account receivable
Write off decrease AR and as well as Allowance for credit losses.
When company determine the write off this is the journal:
Dr Allowance for credit loss $100
Cr Accounts Receivable
When you do any question make sure you read !!! Agh
AR rollforward it to go through all the activities on account and arriving at ending balance.
Transfer of Receivables
1. Secured borrowings
2. Factoring
3. Assignment
4. Pledging
Transfer of receivable:
It must be determined if the transaction is a sale or borrowing transaction. If the below conditions are met, control has effectively passed to the transferee:
1. transferred assets have been isolated from the transferor
2. the transferee is free to pledge or exchange the assets
3. transferor does not maintain effective control over the transferred assets through either one of the following:
*agreement that requires the transferor to repurchase the assets
*agreement that requires the transferor to return specific assets
If the conditions are not met, then it is borrowing transaction.
If sale the transferor will remove the receivable from its books and record a gain or loss on the sale.
Selling its receivable to a bank for a fee is called factoring or discounting.
Factoring the is the sale of short term AR. With recourse (seller’s risk), or without recourse (buyers risk).
Even when sells without recourse the could be losses not related to collectibility, eg. return sale, dispute it’s called factor’s holdback. Due from factor.
Discounting is a sale of long term Notes Receivable.
Factored with recourse:
AR $100, fee 3%,$5 bed debt liability
Dr cash ($100- 3%) $97
Dr loss on factoring (100-3%)+5. $8
Cr AR $100
Cr recourse liability $5***
When accounts are deemed uncollectible the transferor remits the necessary cash to the factor:
Dr recourse liability $5
Cr cash $5
Factor without recourse: sale
At $100, 5% of AR as allowance for sales return, 9% fee
Dr cash ($100 -5% -9%) $86
Dr Due from factor ($100 -5%) $5
Dr loss on factoring ($100-9%) $9
Cr AR $100
!!!! Discounting Note Receivable !!!!
Interest Bearing
Face value of notes receivable
+ Interest at maturity
———————————————
Maturity value
- bank discount*
———————————————-
Net cash proceeds from bank
*MV x discount rate x remaining time
Noninterest bearing
Face value of notes receivable
- banks discount*
————————————————
Net cash proceeds from bank
*MV x discount rate x remaining time
Interest is included in the face value of the note.
AR are written off during the period for uncollectible. The entry is recorded with a Dr to Allowance and Cr to AR.
It has NO effect on the credit loss expense and has no effect on total current asset bs the Dr and Cr are to asset and contra asset accounts.
Capital loss expense - no effect
Working capital - no effect
AR decrease -) Allowance decrease
Factoring receivables with or without recourse
Determining net proceeds from factoring
Gross account receivable
Less: factoring fee
Less: factors holdback
—————————————————
Net cash proceeds
For NR discounted with recourse, it is reasonably possible that the customer will default. The company must disclosed is the footnotes the Maturity amount.
Recovered written off uncollectibles cause:
- AR balance unchanged
- Carring value of AR decrease
- Allowance account increase
- credit loss expense - no effect
To calculate average account receivable balance for the company at any point in time, take any all sale divide by 365, equals $1,808.22 per day.
Multiply sale per day by average collection period 25.
AR is always recorded with applying the trade discount, but sales discount is recorded as gross or net method.
Factoring: - sale of short term AR
Discounting: - sale of long term NR
At the year end the allowance is adjusted for changes in credit risk:
1. if the credit risk adjustment requires an increase in the allowance, a debit to the credit loss expense is recognized
2. If a decrease is required, a reversal of the credit loss expense is reported on the income statement
Q29
Receivables not incurred in the ordinary course of business
At a reasonable or fair stated interest rate?
YES - record at Present Value
NO - receivable collectible within a year? Customary trade term?
- yes - ignore interest component and record at FV
- no - record at PV using the fair interest rate
Receivable may arise from credit sales, loans, or other transactions. Receivables not incurred in the ordinary course of business are recorded at present value of the future payment. When the interest rate is not considered fair or is unreasonably low ie 3% compared to the market rate, the receivables is carried at the PV of payments discounted at fair ie. market interest rate ie. 8%.
GAAP permits an entity to ignore the interest component if 1. the entire receivable will be collected within a year and 2. the terms of the sale are customary in the trade. For long term receivables and short term sales not under customary trade terms ie due in 30, 60 days), the entity is normally required to calculate interest using a fair rate of interest ie 8%.
FV $10
Interest payable at maturity $1.5**
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Maturity value $11.5
PV factor (8%, 5 years) x .680
——————————————————-
PV $7.820
***10x3%x5years
