Lecture 10: Receivables Flashcards
Accounts Receivable
arise from the sale of goods or performance of services. If not related to normal operations these amounts may be due from officers, employees, SH, then they are reported separately from trade accounts receivable
Valuation of Receivables
AR should be reported at their NRV, gross amount of AR less estimates of amounts that won’t be collected due to:
- Uncollectible accounts receivable
- discounts: 2/10, N30
- Trade Discounts: recorded net of any sale or trade discount
- sales and return allowance: contra to sales
Uncollectible AR
Dr. AR 100
Cr. Sales 100
Dr. Bad Debt Expense 5
Cr. Allowance for Uncollectible Accounts 5
NRV= 952 Methods to calculate Bad Debt Expense:
GAAP: IS Approach and BS Approach
There is a Direct Write off Method which is used for tax purposes.
Direct Write-Off
Used for Taxes Only. Not GAAP: not matching because bad debt expense is not recorded @ time of sale, Not Conservative: AR carried at face which will overstate the AF balance
-Bad Debt Expense is recognized when a specific account is determined to be uncollectible, no valuation account is used.
-AR is reduced when accounts written off and recorded as bad debt expense
Dr. Bad Debt Expense
Cr. AR
IS Approach: % of credit sales method
-Base the bad debt expense on percentage of credit sales
-record expense at point of sale, emphasizes matching
FORMULA: Credit sales (not total sales)
X % estimate of amounts not collectible
=bad debt expense
-Allowance for Bad Debt Expense reduces the CV of AR to NRV
^referred to as valuation account
^reported contra-asset to AR
^increased when bad debt expense is recorded
^Decreased when accounts written off
^Increased when recoveries occur
Balance Sheet Approach: % of receivables method
-Aging of AR
-Age all the outstanding ARs
-Emphasis on Asset Valuation principle
FORMULA: Outstanding AR X % Uncollectible AR (Mgmt Estimate) /Allowance for bad debts (target amount)
-Separate calculation may be done for different AR categories based on age
-Entry made to adjust the allowance to calculated amount: offset is adjustment to bad debt expense
JE to record Bad Debt Expense and a Write OFf
Record Bad Debt:
Dr. Bad Debt Expense 5
Cr. Allowance (BS) 5
Write Off AR
Dr. Allowance 3
Cr. AR 3
Then the customer pays you, Recover:
Dr. AR 3
Cr. Allowance 3
Dr. Cash 3
Cr. AR 3
*AR balance is unchanged and so is Allowance Account
4 Techniques to generate cash from a recievable without waiting until is is collected:
- Pledging: client borrows cash and “pledges” the recievable to the lender as collateral to secure the loan. DISCLOSE in a footnote
- Assigning: client borrows cash and agrees to tuse proceds from receivable to repay lender
- Factoring: converts AR into cash by assigning or selling it either with or without recourse to a factor
Sale without recourse
client sells receivable to another party with the buyer assuming the risk that the recievable may not be collectible
Sale with recourse
The client sells the receivable to another party with the buyer retaining the right to demand the client make good on the receivable if the customer does not pay as promised.
Transfers and Servicing of Financial Assets
transfer of financial assets to another entity. May invlove single entire asset such as mortgage loan or a group of assets such as an entity’s AR, or a participating interest in an asset such as a percentage of the entire financial instrument.
When a component of a financial asset is NOT considered a participating interest upon transfer:
it will be accounted for as a secured BORROWING with pledge of collateral
When a component of financial instrument IS considered a participating interest, its characteristics are:
- represents a porportionate interest in the entire instrument
- all cash flows from the instrument (other than those allocated as compensation for services) are divided porportionately among participating interest holders
- The rights of all particiapting interest have th esame priority and are not subordinate to one another
- all participating interest must agree in order for a party to pledge or exchange the entire instrument
If control has been surrendered:
the transfer will be recognized as a SALE along with related g/l
If control has been surrendered it is considered a sale only when ALL 3 conditions are met:
- transferred instrument have been isolated from the transferor
- Transferees have the right to pledge or exchange the asset it recieved without restircitons and without providing more than a trivial benefit to transferor
- transferor does not maintain effective control over the financial instrument
In the case of pledging, assigning as collateral for a loan, the company:
remains the legal owner of the financial obligation and records the liability for amount borrowed:
dr. Cash
cr. NP
In the case of pledging, assigning as collateral for a loan, the company can record at face on the BS:
Dr. AR Assigned
Cr. AR
If control is surrendered adn the transfer is a sale, two other factors should be considered:
- Factors Holdback
2. Recourse Obligation
Factor’s Holdback
“Due from factor” is an amount which provides a margin of protection against sales discounts, sales returns and allowances, and disputed accounts.
Recourse Obligation
probable uncollectible accounts, an amount included as prteciton for the transferee against uncollectible accounts, such obligations result in a continuing interest in the asset
Example: Entity with AR of NRV: 35K transfers them to another entity for 30K
If control is not surrendered, "secured borrowing"
Dr. Cash 30K
Dr. Interest Expense 5K
Cr. Note Payable 35K
If Control is surrendered, "sale", transferee withholds 5K from the proceeds tor protection against future reductions resulting from returns, allowances, etc
Dr. Cash 25K
Dr. Due from Factor 5K
Dr. Loss of sale 5K
Cr. AR 35KFactoring
The sale of ST AR, a factoring fee is applied by the buyer and is a straight percentage of the factored receivables. Can be w/ or w/o recourse
Discounting
The sale of LT Notes Receivables. A discount rate is applied by the buyer and is an annualized rate that will vary depending on the length of time until collection is due. Generally equal to the PV of expected future cash flows.
Notes Receivable Discounting
When an interest bearing NR is sold to a bank, the bank first determines the maturity value of the notes, total payment of principal and accrued interest that is due at maturity. Then reduce this amount by the discount rate and bank will pay net of this.
Formula for Net proceeds on a NR
Face
+Interest (Interest= faceXinterest rateX term)
=Maturity Value
- Discount (Maturity Value X Discount Rate X Time remaining)
= Proceeds
Transfers of participating interests characteristics
- interst represents a proportionate interest in the entire instrument
- all cash flows from teh instrument are divided proportionately
- each participating interest is given same priority
- No entity has the ability to pledge or exchange the entire instrument without consent or all
When a transfer of participating interest qualifies as a slea:
- Consideration recieved is recognized at FV
- Cv of entire instrument is allocated between the particpating interest transferred and the interests retained on the basis of their relative FV
- Remaining CV becomes the CV of the retained interests
Servicing Financial Assets and Liabilities
These include admin functions, monthly statements, collecting payments, allocating payments between principal and interest, sending tax info
Asset: excess of PV of the fees expected to be earned for servicing a financial instrument over the pV of costs expected to be incurred
Liability: Excess of PV of costs expected to be incurred serviceing a financial instrument over the PV of the fees expected to be earned for doing so.
A servicing asset or liability is recognized at ______, regardless of whether or not a consideration was received.
FV
Once recognized, servicing assets or liabilities may be accounted for under ______method of ______method
Amortization Method, FV Method
Interest - Only Strip (IO strip)
The interest portion of mortgage, Treasury or bond payments, which is separated and sold individually from the principal portion of those same payments.
- Considered financial instruments, not servicing assets
- entity recieves a proportionate amount of each interest payment received.
- reported at FV when received
- accounted for similarily to AFS or Trading securities
Securitization
process of converting financial assets into securities to make it easier to transfer. May be classified as either:
- Pay through: payments used to pay off debt securities
- Pass through: payments attributed to investors
Accounting for Collateral
when a debtor provides a creditor with collateral for a lona, the accounting for it will depend on who retains control of the collateral. Mostly the transferor “debtor” retains control of the collateral:
- It remains as asset on the debtors books
- collateral for debt is disclosed
- transferee “creditor” does not recognize the asset
Receivable Impairment
a loss recognized on the IS, with a reduction in a loan receivable when amounts are not expected to be collected according to contractual terms. Write loan down to either: PV of future principal and interest inflows, loans market price, or FV of the collateral.
LT Receivables are recorded at :
PV, time value of money
Example 1: Notes Recieved for Goods or services at a reasonable rate:
PV of note is smae as the face amount and book value of asset is 6K.
Dr. NR 10K Face
Cr. Discount 0
Cr. Asset 6K
Cr. Gain Sale 4kExample 2: Non Interest Bearing NR: if interest rate is not stated or is unreasonable, use the:
FMV of goods or the FMV of note, assume FMV is 9000
Dr. NR 10K
Cr. Discount on NR 1000
Cr. Equipment 6000
Cr. Gain on Sale 3000Example 3: If interest rate is not stated, the FMV of goods or Note is not determined, you must:
IMPUTE the interest rate. PV of note in 2 years at 10% is .8265
Dr. NR 10K
Cr. Discount on NR 1735 (10K - 8265)
Cr. equipment 6000
Cr. Gain on sale 2265
Under IFRS Receivables:
- Transaction costs to acquire receivable are included in the CV reducing the effective rate (GAAP they are not)
- receivables required to be tested for impairment each period, impairment loss may be recovered ( GAAP only test if reason to believe, losses may NOT be recovered)
- Instead of allowance for IFRS uses provisions for.
