Chapter 7: Cash and Receivables Flashcards
Journalizing gross method of Accounts Receivable
Record Accounts receivable at total price without discount
When payment is received within discount period:
Debit: Sales Discounts (contra-account, deduction from sales to arrive at net sales)
Journalizing Factoring Sale with Recourse
Debit Cash Received
Debit Due from Factor (proceeds retained to cover potential allowances)
Debit losses on sale (carrying value less net proceeds)
Credit Accounts Receivable (full Amount)
Credit Recourse Liability
Net Proceeds = Cash received + due from factor - less recourse liability
Journalizing factoring sale without recourse
Debit Cash (cash received)
Debit Due from Factor
Debit Loss on sale of receivables
Credit Accounts receivable (full Amount)
Due from Factor account
Reported as a receivable (Debit up, credit down)
Proceeds retained by the factor to cover probably sales discounts, returns and allowances.
Factor side: recorded as due to customer
Recording fair value option
Must make an adjusting entry so that the notes reflect fair value and it is recognized in unrealized holdings
Gain
Debit Notes Receivable
Credit Unrealized holding gain or loss (income)
Loss:
Debit Unrealized holding gain or loss
Credit notes receivable
Fair Value Option
Can start using when financial instrument is acquired OR when an event triggers a change, not randomly.
Companies now have the option to record fair value in their accounts for more financial instruments - including receivables.
Unrealized gains and losses are included as part of net income.
If company elects to use the fair value option it must continue to use it as long as the company owns the financial instrument
Unrealized holding gain or loss
Net change in fair value of a receivable from one period to another (EXCLUSIVE of interest revenue)
Note for property goods or services when face value does NOT equal fair value
DIDN’T UNDERSTAND
Debit Notes receivable (note maturity value)
Credit discount on N/R (Note value - fair value)
Credit Asset (historical price)
Credit Gain on disposal of asset (fair value - historical price)
Carrying Amount (note receivable) on financial statements
Note Receivable
Discount on note receivable
Note + Discount = carrying amount
Note - Premium = carrying amount
Notes Receivable on Balance sheet
Reported at present value of cash they expect to collect.
Difference between interest rate and market rate is recorded as a discount or a premium, amortized over the life of the note.
Also consider allowance for doubtful accounts
Must disclose fair value in the notes
Imputed Interest Rate
DIDN’T UNDERSTAND
Journaling Interest received on note issued at discount
Effective interest method:
Debit Cash (interest payment received)
Debit Discount on note received (amortized amount)
Credit interest revenue (total)Premium on note receivable
Present value > face value
Premium amortized across life of note to REDUCE annual interest revenue
Effective interest method
DIDN’T UNDERSTAND
Method of amortizing discount (or premium) of notes receivable
Journalizing notes receivable when effective rate of interest > stated rate
When present value of principle + present value of interest > face value of note
Debit Notes Receivable
Credit Discount on Notes Receivable
Credit Cash
Discount on note receivable then amortized into interest payments
Jounalizing Notes Receivable: zero interest bearing notes
Debit Notes Receivable (face value)
Credit Discount on N/R (difference)
Credit Cash
Amortizing discount:
Debit Discount on notes receivable
Credit interest revenue
Discount on notes receivable
Contra asset account
Debit decrease, credit increase
Implicit interest rate
On zero-interest bearing notes
Future Value - present value = interest amount
then amortized over life of the note
Interest bearing vs zero interest bearing notes
Interest bearing - include a stated rate of interest
Zero interest bearing- includes the interest as part of the face amount:
- Present value = cash paid to user
- Future value = face value
- Interest = difference
Journaling notes issued at face value
Purchase:
Debit Notes Receivable (total amount paid)
Credit Cash (total amount paid)
Recognizing Interest:
Debit Cash
Credit Interest Revenue
Present Value of a note issued
Present value of Principle + Present value of Interest = Present value of note
Face value less present value = interest
Notes Receivable
Negotiable instrument from a maker to a payee
may be sold or transferred
considered liquid even if long term because can be converted to cash by a sale
Allowance method for uncollectable accounts on financial statements
Receivables shown at net amount expected to be collected
Accounts Receivable
Less allowance for doubtful accounts
Some risk that this can be used to manage earnings (high estimate in good periods balanced against low estimates in bad periods)
Aging schedule
Used to determine allowance for doubtful accounts (bad debt expense)
Control device to identify delinquent accounts
classifies customer balances by the length of time they have gone unpaid (ex: 1-30 days, 31-60, 61-90, 90+_
Alternate ways to estimate bad debt
Using customers credit ratings:
- useful if historically the business has seen differences in payment across credit ratings
Probability weighted discounted cash flow model (for an individual loan/ receivable)
Estimating Uncollectables: percentage of receivables
More appropriate than percentage of sales
- may use one composite rate for all receivables
- may set up an aging schedule with different percentages for different aging categories
Because this estimates using total A/R you have to consider the current allowance for doubtful accounts balance when making the adjustment
Technique must be used consistantly
Journalizing Recovery of an uncollectable account
Requires two entries (affects only balance sheet accounts)
Reverse Write Off:
Debit A/R
Credit Allowance for Doubtful Accounts
Recognize collection:
Debit Cash
Credit A/R
Journaling Allowance Method for uncollectable accounts
REQUIRED when amounts are material
Uncollectable accounts estimated at the end of each period so that expense is recognized in the period when the sale occurs
Estimate:
Debit Bad Debt Expense
Credit Allowance for Doubtful Accounts
(contra account)
Write-Off:
Debit Allowance for Doubtful Accounts
Credit Accounts Receivable
Journaling Direct write-off method for uncollectable accounts
Only acceptable when amount is immaterial
Debit Bad Debt Expense (inc)
Credit Accounts Receivable (dec)
Bad debt expense account = only for actual losses (not estimates)
Fails to record expenses in same period as revenue AND amount expected to be collected from A/R is not accurate on the balance sheet
Credit Loss Accounts
Bad Debt Expense
+
Uncollectable accounts expense
(expense = debit increase, credit decrease)
Allowance for Doubtful Accounts (Contra asset. Debit decrease, credit increase)
Cash
Includes: Money orders, certified checked, cashiers checks, personal checks, bank drafts, savings accounts, petty cash & change funds
also money market funds with checking account privileges
Cash Equivalents
Short term, highly liquid investments
- readily convertible into known amounts of cash
- so near maturity that there is an insignificant risk of change in value due to change in interest rate (Maturities of 3 months or less)
Treasury Bills, commercial paper, MMF
MAY STILL HAVE TO GET WRITTEN DOWN
Restricted Cash
If immaterial amounts: not segregated from cash
If material: can be current or long term asset depending on date of availability (current = year or one operating cycle)
Exportation of currency regulations
Compensating Balances
That portion of any demand deposit (time deposit or certificate of deposit) maintained by a corporation which constitutes support for existing borrowing arrangements of the corporation with a lending institution
Minimum balance required by creditors
SEC recommends separately listing on balancing sheet
Bank overdrafts
Current liabilities section of the balance sheet
Generally not offset against cash unless cash is present in another account in the same bank where the overdraft occurred
Trade Receivables
Accounts receivable and notes receivable
Amounts owed for goods or services rendered
A/R usually 30-60 days
Notes may be short term or long term
Non-Trade Receivables
Advances
Deposit
Dividends/ Interest receivable
Outstanding Claim
Generally reported separately
Journaling Recognition of Accounts Receivable
Change of control is a deciding factor in determining when a performance obligation is satisfied:
- Vendor has right to payment from customer
- Customer has legal title to goods
- Customer has physical possession of goods (and vendor has neither)
- Customer has accepted asset
Usually at transaction price
Events that may affect transaction price
All FUTURE events
1) Trade discounts
2) Cash discounts (sales discounts)
3) Sales returns and allowances
4) time value of money
Trade Discounts
Including quantity discounts
Purchase price recorded as net price
Sales price recorded at net price
Discount and allowances accounts
Cash Discounts
Sales Discounts
Intended to induce prompt payment (discount for early payment)
Record A/R at amount EXPECTED TO RECEIVE
If discount not taken credit sales discount forfeited account
Sales Discount Forfeited
Shown in revenues and gains section of income statement
Credit Normal Balance
Sales Discount
Contra Revenue Account
Debit Normal Balance
Sales Returns and Allowances
Contra Revenue Account
Debit Normal Balance
Debited when a return an allowance is granted in same period as sale
Debited to recognize potential future period returns
Allowance for Sales Returns and Allowances
Contra Asset Account
Credit Normal Balance
Credited to recognize potential future period returns and allowances
Receivables
Loans and receivables
Claims held against customers and others for money, goods, or services
Either current (current operating cycle or year) or non-current
Trade vs non-trade
Time value of money is NOT considered for current receivables
Reason to transfer Receivables
- to accelerate receipt of cash
- to get cash inflows - as a form of secured borrowing (avoids violating lending agreements)
Factors
Finance Companies or banks that buy receivables from businesses for a fee and then collect from a customer
Mastercard/visa etc are a type of factoring
Factoring sale without recourse
Outright sale: seller of receivables assumes no further responsibility for any credit losses associated with the transferred receivables
Factoring sale with recourse
Seller guarantees payment to purchaser in the event the debtor pays to fail
requires “financial components approach” for seller’s continuing involvement
Financial Components Approach
Each party to a sale only recognizes the assets controlled and liabilities incurred after the sale
Pledge
Custodial Agreement when a company transfers receivables for custodial purposes (collateral in a loan)
Journaling Secured borrowing
Debit Cash
Debit interest expense
Credit Notes Payable
+ normal entries for collecting receivables / paying a note payable
Secured borrowing
Receivables assigned as collateral for a note
- firm continues to collect A/R
- bank assesses finance charges of A/R and note
- Firm pays bank cash collected on receivables
- Firm must recognize discounts, returns, allowances, bad debt
- Money from collections used to retire note obligation WITH interest
Conditions for a sale
1) Transferred asset has to been isolated from the transferor (transferor no longer has access)
2) Transferee now has right to pledge or exchange the transferred assets/ interest
3) Transferror does not maintained effective control over the transferred asset (via an agreement to repurchase/ redeem before maturity)
If these conditions not met it is secured borrowing not sale)
Securitization
Takes a pool of assets (various receivables) and sells shares in the pools of interest and principle
securities batched by asset
Rules of classifying receivables
- segregate types of receivables if material
- appropriately offset valuation accounts against the proper receivables accounts
- Receivables classified as current will be converted into cash in one cycle/ one year
- Disclose any loss contingencies
- Disclose any receivables pledged as collateral
- Disclose the credit risk in receivables and how that risk was arrived at/ assessed
- Disclose any changes in allowances for credit losses
Accounts Receivable Disclosures
FASB requires:
- disclose aging of receivables (roll forward schedule of allowance for doubtful accounts from beginning to end of a period)
- non-accrual status of receivables by class
- impaired receivables by types
- Credit and risk
- Any concentrations of credit risk that could impact collection
Accounts Receivable Turnover
To see how successfully a company collects receivables
Number of times on average a company collects its receivables in the period
Net sales / Average Net accounts receivable
Average Net A/R : Beginning + ending balance / 2
(Net sales should be net credit sales but that information is rarely available)
Average Days to collect receivables
AKA days outstanding
Effectiveness of company’s credit and collection policy
Accounts receivable turnover / 365
ideally not much longer than the credit term period
Collectibility assessment based on future cash flows
- Schedule is prepared comparing contracted cash flow to expected cash flow
- impairment recorded: difference between recorded investment and present value of expected cash flow
Impairment recorded to bad debt expense/ allowance for doubtful accounts
Cash
- Most liquid asset
- Standard medium of exchange
- Basis for measuring and accounting for all items
- Current asset
includes: money orders, certified checks, cashiers checks, personal checks, bank drafts, savings accounts, money market funds with checking account privileges, petty cash and change funds
Receivables
Claims held against customers and others for money, goods, or services
Either current or non current
trade vs non-trade
time value of money is NOT considered for current receivables
Allowance method
- Improved matching (over direct write off)
- Losses are estimated
- Percentage-of-sales or percentage-of-receivables - required by GAAP whenever amount is material
Imprest bank accounts
to make a specific amount of cash available for a limited purpose. Transfers amount to cover specific expense (eg. payroll) from general checking
general checking
account company routes all transactions through. money may then be disbursed to other accounts
Banking controls
- minimize cash on hand
- use bank code numbers, not check numbers on deposit slip
- multiple accounts to minimize collection float
- memorandums to record: bank charges, interest earned, notes collected
Reconciling balance per books + balance per bank shows lag times and creates additional records
Collection Float
The difference between the amount of the deposit accounting to the company’s record and collected cash according to bank records
Lock-box system
System where customers send their checks to a PO box that belongs to a bank. A bank employee empties the box daily and records the deposits into the company’s bank account.
This accelerates the availability of cash and usually provides records of checks collected
worth it in income from faster collections > lockbox cost
Six principals of controls activities
- establishment of responsibility
- segregation of duties
- documentation of procedures
- physical controls
- independent internal verification
- human resource controls
Imprest system for petty cash
A way to account for petty cash by maintaining a constant balance in the petty cash account
- at any time cash plus petty cash tickets must total the amount allocated to the petty cash fund
- reimbursed when depleted or at the end of the accounting period
Principals of internal controls: physical controls
Includes:
- minimize cash on hand
- safes, vaults, safety deposit boxes
- locking cabinets, warehouses
- computer security (passwords, biometrics)
- video monitoring
- sensors/ tags
- time clocks
- alarm systems
- use of indelible ink/ watermarks
- anything to limit physical access to secured items/ cash
Petty Cash Fund Controls
- surprise counts to confirm receipts + cash = original (imprest) amount
- cancelling / mutilating paid petty cash receipts so they cannot be resubmitted
Sarbanes-Oxley act regulations
Applies to publicly traded US corporations
Companies must:
- develop principals of control over financial reporting
- continually verify that the controls are working
- issue internal control report
independent auditors attest to the adequacy of internal controls (PCAOB oversees)
auditing firm cannot supply auditing and consulting services to the same client
requires a company ensures employee supervision / certifications
Bank Reconciliation
Schedule explaining difference between bank and company’s record of cash
- deposits in transit
- outstanding checks
- bank charges
- bank credits
- bank/depositor errors
Can recognize only one side but generally reconcile both to correct balance
Pledging Receivables
When a business uses its receivables as securities for a loan
Factoring
Factor: buys receivables from businesses and then collects from the customers
typically charge a commission to the company - usually about 1% to 3% of receivables purchased
Reasons to sell receivables
1) receivables may be the only reasonable source of cash
2) billing and collection are time consuming/ costly
sell to a factor (finance company or bank) or only accept credit card sales for credit
- this shortens the operating cycle by accelerating the receipt of cash from collections
Trade receivables
Accounts receivable and notes receivable
amounts owed for goods or services rendered
A/R usually 30-60 days
Notes may be short term or long term
Non-Trade receivables
Advances, deposits, dividends/ interest receivable, outstanding claims
generally reported separately
Compensating balances
That portion of any demand deposit (time deposit or certificate of deposit) maintained by a corporation which constitutes support for existing borrowing arrangements of the corporation with a lending institution
minimum balance required by creditors
SEC recommends separately listing on balance sheet
Cash Equivalents
Short-term, highly liquid investments
- readily convertible into known amounts of cash
- so near maturity, insignificant risk of change in value due to change in interest rate (maturities of 3 months or less)
Treasury bills, commercial paper, MMF
May still get written down
Petty Cash Account
Asset Account
Establish
Debit (increase) Petty Cash
Credit (decrease) cash
then only record receipts to journal when refilling the cash
Debit various expenses (listed out)
Credit cash (balance to bring fund to imprest amount)
Missing petty cash goes to cash over/ short
Cash Over/Short account
Income Statement account - close at the end of a period
Categorized as misc revenue if credit balance (cash over)
Categorized as misc expense in debit balance (cash short)
Short:
Debit Cash Over Short Amount
Credit Sales
Over
Debit Sales
Credit Cash Over Short Amount
Recording NSF Check
Insufficient funds
Debit (increase) accounts receivable
Credit (decrease) cash
A/R Interest Accrual
Debit (increase) A/R interest amount
Credit (increase) interest revenue
Allowance method for uncollectable accounts
Required by GAAP
Record estimated uncollectables in an adjusting entry
Debit Bad debts expense
Credit Allowance for doubtful accounts
Allowance for doubtful accounts : contra-asset account that lowers the value of the asset account
Allows for matching within a period
When writeoff is realized:
Debit Allowance for Doubtful Accounts
Credit Accounts Receivables
Usually percent of sales (income statement) or percent of receivables (balance sheet
A/R payment within discount period
Debit increase cash
Debit increase sales discount
Credit decrease A/R (full amount)
(only if recorded at GROSS amount)
A/R payment Lost discount
NET Amount recorded
Debit Cash (full amount)
Credit discount’s forefeited (discount amount)
Credit A/R (net amount)
Note Receivable Repayment
Debit Cash
Credit Note Receivable
Credit interest Receivable (if already accrued) or Interest Revenue (if not yet accrued)
Notes Receivable Issuance and accruals
Debit Note Receivable
Credit Cash (for a loan) or Sales (credit sales) or A/R
When interest accrues
Debit interest receivable
Credit interest reveue
Direct write off of uncollectable accounts
Not GAAP - violates the matching principal
means the receivable is not stated at net value on the reports
Debit bad debt expense
Credit accounts receivable
listed as an expense on the income statement
If then recovered had to reverse the write off journal entry before journalizing cash payments
Disposing of notes receivable Honored
Generally note sold to factor before maturity
Disposing of notes receivable dishonored
Not paid in full at maturity
Defaulted - note no longer negotiable
depends on what end result is expected
Expecting collection: move to A/R
Debit Accounts Receivable for face and interest
Credit notes receivable & interest receivable
write off; write off face value only (no interest recognized)
Debit allowance for doubtful accounts
Credit notes receivable
Receivables sold to a factor (aka Factoring)
Debit Cash
Debit service charge expense
Credit accounts receivable (decrease)
Recognition of A/R
Change of control is deciding factor in determining when a performance obligation is satisfied
- vendor has the right to payment from the customer
- customer has the legal title to goods
- customer has physical possession of goods (and vendor does not)
- customer has accepted asset
usually recorded at transaction price
Events that may affect the transaction price
All future events:
- trade discounts
- cash discounts (sales discounts)
- sales returns and allowances
- Time value of money
Trade Discounts
Includes quantity discount
Purchase price recorded a net price
sales price recorded at net price
Cash Discounts
Sales discounts
Intended to induce prompt payment (discount for early payment)
Record A/R at the amount EXPECTED to receive (net of discounts)
If discount not taken then Credit sales discount forfeited
Recovery of an account previously written off
Two part entry
Debit A/R
Credit Allowance for Doubtful Account
Debit Cash
Credit Accounts Receivable
Have to put it back in A/R before can pay it off
Sales discounts forfeited
Shown in revenues and gains section of income statement
credit normal balance
Sales discount
Contra-revenue account
Debit normal balance
Sales returns and allowances
Contra revenue account
Debit normal balance
Debited when a return or allowance is granted in the same period as the sale
debited to recognize potential future period returns
Allowance for sales returns and allowances
Contra asset account
credit normal balance
credit to recognize potential future period returns and allowances
Bank overdrafts
Current liabilities section of balance sheet
generally not offset against cash unless cash is present in another account in the same bank where the overdraft occured
Restricted cash
Not segregated from cash if immaterial amounts
if material can be current or long term asset depending on date of availability
current= year or one operating cycle
exportation of currency regulations
Bank reconciliation
Single date
Cash Balance per statement \+ deposits in transit - outstanding checks \+/- bank errors = balance
Cash balance per books \+ notes collected by bank - NSF / bounced checks - bank service charges \+/- company errors = balance
reconciled balances should match
adjusting entries required for any items adjusting the cash balance per the books
Valuing notes receivable
Like A/R required that notes receivable are recognized at their net receivable cash value
also uses allowance for doubtful accounts estimated similarly to A/R
Net Realizable (cash) value
NRV
Accounts receivable less uncollectable A/R = net realizable cash value of A/R
Computing Interest
Face Value (principle) x Annual interest rate x time as a fraction of a year = interest
time in terms of year = # months / 12 or #days /360
(used to use 360 instead of 365 - may be different now)
date of issue is omitted due date is included
Percentage of receivables basis for estimating allowance for doubtful accounts
Based on an aging schedule estimated percentage of each category of days past due
takes into account existing allowance for doubtful accounts account balance
