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.
