F4.1 Working Capital and Its Components Flashcards
Working Capital
Work in capital = Current assets – Current Liabilities
Current Assets
Current assets = resources that are expected to be realized or consumed within the business cycle or a year, which went whichever is longer
Includes – Cash – Trading securities - Other short-term investments – Accounts and notes receivable – Trade installment receivables – Inventories – Other short-term receivables – Prepaid expenses – Cash surrender value of life insurance
Current Liabilities
Current liabilities = obligations to be settled by the use of a current asset, or rolled over into another current liability.
Current liabilities arise from regular business operations or bank borrowings
Curent Liabilities Include: – Trade accounts and notes payable – Current portions of long-term debt – Dividends payable – Accrued liabilities – Payroll liabilities – Taxes payable – Advances from customers
Under US GAAP, a short-term obligation can be excluded from current liabilities if the company intends to refinance it on a LT-basis
– Not allowed under IFRS
Cash and Cash Equivalents
Cat = currency and demand deposits
Cash equivalents = short-term, highly liquid investments readily convertible to cash, maturity less than 90 days
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Cash and Cash Equivalents – Included in Cash and Cash Equivalents
Coin and currency on hand (including petty cash)
– Checking accounts
– Savings accounts
– Money market funds
– Deposit held as compensating balances against borrowing arrangements with a lending institute that are not legally restricted
– Negotiable paper
– Bank checks, money orders, traveler’s checks, bank drafts, and cashier’s checks
– Comercial paper and T-bills
– Certificate of deposits with ≤ 90 days maturity
Not cash or Cash Equivalents:
– Time certificates of deposit with original maturity > 90 days
– Legally restricted deposits held as compensating balances against borrowing arrangement with a lending institution
Cash and Cash Equivalents – Restricted vs Unrestricted Cash
Disclose nature, amount, and timing of restrictions in footnotes..
Restricted cash associated with current asset or current liability = current asset
– List separate from unrestricted cash
Restricted cash associated with concurrent asset or concurrent liability = noncurret asset
– Separate from Investments or Other Assets section.
Cash restricted by management = current or LT asset depending on anticipated date of disbursement
– Indicate that it is restricted cash
Cash and Cash Equivalents – Bank Reconciliation
Simple Reconciliation - explains differences between cash balance per bank and cash balance per depositors
Reconciliation of cash receipts and disbursements (4 column reconciliation) = proof of cash
– Need information of rthe present month and prior month
Cash and Cash Equivalents – Simple Reconciliations
Deposits in Transit = Bank balance understated
Outstanding Checks (not yet presented to bank) = Bank balance understated
Service charges (deducted by bank) = Book balance overstated
Bank collections (on behalf of depositor) = Book balance understated
Errors – depends on nature of error
Nonsufficient Funds (charged for dishonored check) = book balance overstated
Interest income = Book balance understated
Accounts Receivable
A/R = oral promises to pay
A/R - current assets
Trade receivables or non-trade receivables
– Non-trade receivables = A/R from persons other than customers
Accounts Receivable – Discounts
Discounts quoted as 2/10, n/30
– 2% discount if pay within 30 days, A/R due latest 30 days
Can record using the gross or net method
– Gross method = record sale without regard to available discount
– Net discount = record sale net of available discount
Trade discounts applied sequentially
Accounts Receivable – Discounts: Gross Method Journal Entries
To record Sale
A/R (Gross Amount)
Sales Revenue (Gross Amount)
If Discount Taken
Cash (Discounted Amount)
Sales Discount Taken
A/R (Gross Amount)
If discount not taken
Cash (Gross Amount
A/R (Gross Amount)
Accounts Receivable – Discounts: Net Method Journal Entries
To record Sales
A/R (Discounted Amount)
Sales Revenue (Gross Amount)
Discount Taken
Cash (Discounted Amount)
A/R (Discounted Amount)
Discount Not Taken
Cash (Gross Amount)
A/R (Discounted Amount)
Sales Discount not taken
Accounts Receivable – Sales Returns and Allowances
To record Sales:
A/R
Sales Revenue
To record a sales return
Sales return and allowances
A/R
Sales Return and Allowances is a contra Sales account.
– Charge returns to this account rather than deduct Sales Revenue. This way, can disclose amount of Returns.
Uncollectible Accounts Receivable
2 Methods: 1. Direct Write-Off Method – Not GAAP – Used for Tax purposes 2. Allowance Method = US GAAP
Uncollectible Accounts – Direct Write-Off Method
To record Sale
Accounts Receivable
Sale
To record account become uncollectible
Bad Debt Expenses
Accounts Receivables
Subsequent collection of account
Cash
Uncollectible Accounts Recovered
Uncollectible Accounts – Allowance Method
To record sale
Accounts Receivable
Sale
Bad debt expense estimated and charged to allowance account
Bad Debt Expense
Allowance for Uncollectible Accounts
To record write-off when account becomes uncollectible
Allowance for Uncollectible Accounts
Accounts Receivable
Subsequent collection of account
1. First restore account
Accounts Receivable
Allowance for Uncollectible Accounts
2. Record cash collection
Cash
Accounts Receivable
Uncollectible Accounts – Allowance Method: Estimating Allowance for Uncollectible Accounts
3 Methods
- % of sales method
- % of A/R at year’s end
- Aging of receivables method
Allowance for Doubtful Accounts Analysis
Beginning Balance \+ Bad Debt Expense \+ Recoveries of bad Debt – Accounts receivable written off = Ending balance
Pledging and Factoring Receivables
Pledging of receivables = receivables used as collateral for loan
– Note disclosure
Factoring of receivables = receivables converted into cash by assigning them to a factor
1. Without recourse = sale is final
– Factor assume risk of losses on collections
2. With recourse - factor has option to re-sell uncollectible receivables back to seller
Factoring Receivables with Recourse
Factoring with recourse can be sale or loan (like pledging)
– Sale = journal entries
– Loan = just note disclosure
Factoring with recourse = sale if
– Seller’s obligation for uncollectible accounts can be reasonably be estimate
– Seller has not control over future economic benefits of receivables
– Seller can’t be required to repurchase receivables, but can be required to replace with other similar receivables
Factoring Receivables without recourse, and for with resource that is a sale – Journal entries
Cash
Due from factor (Factor’s margin)
Loss on sale of receivables
Accounts receivable
Factor’s margin is to protect factor against sales returns, sales discount allowances, and customer disputes
Transfers of Financial Assets
Question = is transfer sale or secured borrowing
– Important because entities record only assets it has control over (and the related liabilities), and derecognizes those asset when control over them has been surrendered (and liabilities have been extinguished)
Financial-Components Approach to Transfers of Financial Assets
Focus on control
Divide assets and liabilities into components, and apply accounting methods depending on whether transactions is sale or secured borrowing
Transfers of Finanial Assets – Control
Control is surrendered when
– Assets isolated from transferor
– Transferee has right to pledge or exchange asset
– No repurchase agreement
Control surrendered, and entity has no continuing involvement = sale
– Recognize gain and loss
Control surrendered, but entity has continuing involvement = sale & financial-components approach
– divide assets between those that are sold and those that are not sold
– recognize gain and loss on sold assets
Control not surrendered = secured borrowing
– Gain or loss not recognized
– Note disclosure
Servicing Assets and Liabilities
If entity has contract to service assets and liabilities
– record servicing asset or liability for contract
– Amortize contract
– Assess contract periodically for impairment based on fair value
Notes Receivable
Notes Receivables = written promises to pay a debt
Receivable stated at its present value
Non-interest bearing or below-market interest rate note – value note by imputing the market rate of interest and applying effective interest method.
Discounted Notes Receivables
Holder endorses note to a third party and receives a sum of cash
Discount = difference between cash received by hold and maturity value of note
With Recourse – holder remains contingently liable for ultimate payment of note when it becomes due
– Report discounted notes receivable with discourse on balance sheet with contra account
– Contra account = Notes Receivables Discounted
Without recourse = note essentially sold outright
– Holder has no further liability
– Remove from balance sheet
Dishonored Discounted Notes Receivables
Remove contingent liability as follows
Dr. Notes Receivable Discounted
Cr. Notes Receivable
Notes Receivable Discounted recorded at estimated recoverable amount
