8. Trade Receivable

Question 1

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

Question 2

FACTORED 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

Question 3

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

Question 4

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.

Question 5

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

Question 6

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)

Question 7

Under Direct write off method the AR is recorded at gross amount, no *Allowance of credit loss account. *

Question 8

Collection on AR previously written off:
AR - no effect
Allowance - Increased

Question 9

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
————————————————-
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

Question 10

A Note Receivable typically has two components: principal (FV) and interest.
A noninterest bearing note is one that does not have a stated annual rate of interest but does bear interest because a lender (seller) expects the borrower (customer) to pay for the use of its money (interest).
When the noninterest bearing note is issued, the interest is recorded as a contra account called Discount on NR. It is calculated as the difference between the FV of the note and its PV based on the market rate of interest.

PV payment x present value factor

Noninterest bearing notes receivable in exchange for merchandise sold
Dr Notes Receivable (face amount)
Cr Discount on notes receivable
Cr Sales revenue

Year end adjusting entry
Dr Discount on notes receivable
Cr Interest revenue

The discount on NR is amortized at year end using the effective interest method over the life of the note. The amortization reduces (debit) the discount and increases (credit) interest revenue. When the NR matures the borrower pays cash to the seller for the face amount of the note. The buyer, not the seller, records interest expense.

Journal entry to record noninterest bearing notes receivable receivable for equipment sold

Dr NR (FV) $600
Dr Loss on sale (plug) $30
Cr Discount on NR (calculated) $150
Cr Equipment (carrying amount) $480

Face value $600
Less: PV of NR (PVxPV factor) (600 x .75) $150

Amortization discount:
(600-150) x 10% x 12/12 $45

Question 11

Allowance for credit loss account
————————————————
I $42 beg bal
Write off I $6 w/o reinstated /
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
I

!!!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.

Question 12

Bla

Dr Allowance for credit losses (decrease)
Cr reversal for credit loss expenses

Question 13

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.

Question 14

Factoring receivable with and without recourse
Determining net proceeds from factoring
Gross AR
Less: factoring fee
Less: factor’s holdback
———————————-
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

With recourse
Dr cash $xx
Dr due from factor
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.

Question 15

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.

Question 16

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.

Question 17

If the percentage-of-receivable method is used, the calculated uncollectible receivable represent the ending balance of the allowance for credit losses account.

Question 18

To determine the cash collected from customer:
Credit sale
Deduct: writes off
Deduct: increase in AR balance
Equal: cash collected from customer

Question 19

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 *.

Question 20

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

Question 21

Record the 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%

FV of NR $50
+ interest at maturity 50x8%x2y $8
Maturity value $58
- bank discount 58x10%x1y $5.8
Net cash pro seeds $52.2

Question 22

Noninterest bearing notes receivable, calculating discount:
Face Value of note receivable $100
Less: preset value factor x payments (80)
Discount on Note Receivable $20

Noninterest bearing notes receivable may be used when selling goods or providing services. It is recorded at FMV of goods or services or the FMV of the Note Receivalbe, whichever is more determinable. If neither is known, present value of the future payments is used.
Although an interest rate is not stated, interest is imply in the face value of the note. The implied interest is the difference between face value and PV, and it is recorded as a contra account called Discount on NR. The discount is then amortized (using the effective interest rate method) over the life of the note based on the NR’s carrying value.

Question 23

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.

Question 24

That is also Note Receivable a contractual agreement between a creditor and a debtor to pay a specific amount at a future date . The note receivable is recorded at FV on the day of sale. Records interest accruals for each accounting periods.

on December 31:
Dr Interest Receivable
Cr Interest Revenue

NR matures on Feb 28
Dr cash
Cr Interest Receivable
Cr Interest Revenue (remaining 2 months interest)
Cr Note Receivable (FV)

Question 25

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

Question 26

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

Question 27

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

Question 28

When you do any question make sure you read !!! Agh

Question 29

AR rollforward it to go through all the activities on account and arriving at ending balance.

Question 30

Transfer of Receivables
1. Secured borrowings
2. Factoring
3. Assignment
4. Pledging

Question 31

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.