Chapter 7 1 CHAPTER 7 CASH AND RECEIVABLES

Chapter 7 -1

CHAPTER 7 CASH AND RECEIVABLES Intermediate Accounting 13 th Edition Kieso, Weygandt, and Warfield UCSB Chapter 7 -2

What is Cash? Cash Most liquid asset Standard medium of exchange Basis for measuring and accounting for all items Current asset Examples: coin, currency, available funds on deposit at the bank, money orders, certified checks, cashier’s checks, personal checks, bank drafts and savings accounts. Chapter 7 -3 LO 1 Identify items considered cash.

Reporting Cash Equivalents Short-term, highly liquid investments that are both (a) readily convertible to cash, and (b) so near their maturity that they present insignificant risk of changes in interest rates. Examples: Treasury bills, Commercial paper, and Money market funds. Chapter 7 -4 LO 2 Indicate how to report cash and related items.

Reporting Cash Restricted Cash Companies segregate restricted cash from “regular” cash for reporting purposes. Examples, restricted for: (1) plant expansion, (2) retirement of long-term debt, and (3) compensating balances. Illustration 7 -1 Chapter 7 -5 LO 2 Indicate how to report cash and related items.

Reporting Cash Bank Overdrafts When a company writes a check for more than the amount in its cash account. Generally reported as a current liability. Offset against cash account only when available cash is present in another account in the same bank on which the overdraft occurred. Chapter 7 -6 LO 2 Indicate how to report cash and related items.

Summary of Cash-Related Items Illustration 7 -2 Chapter 7 -7 LO 2 Indicate how to report cash and related items.

Receivables Claims held against customers and others money, goods, or services. for Oral promises of the purchaser to pay for goods and services sold. Written promises to pay a sum of money on a specified future date. Accounts Receivable Notes Receivable Chapter 7 -8 LO 3 Define receivables and identify the different types of receivables.

Receivables Nontrade Receivables 1. 2. 3. 4. 5. 6. Advances to officers and employees. Advances to subsidiaries. Deposits to cover potential damages or losses. Deposits as a guarantee of performance or payment. Dividends and interest receivable. Claims against: a) b) c) d) e) f) Chapter 7 -9 Insurance companies for casualties sustained. Defendants under suit. Governmental bodies for tax refunds. Common carriers for damaged or lost goods. Creditors for returned, damaged, or lost goods. Customers for returnable items (crates, containers, etc. ). LO 3 Define receivables and identify the different types of receivables.

Receivables Nontrade Receivables Illustration 7 -3 Chapter 7 -10 LO 3 Define receivables and identify the different types of receivables.

Recognition of Accounts Receivables Trade Discounts Reductions from the list price Not recognized in the accounting records Customers are billed net of discounts Chapter 7 -11 10 % Discount for new Retail Store Customers LO 4 Explain accounting issues related to recognition of accounts receivable.

Recognition of Accounts Receivables Cash Discounts Inducements for prompt payment Gross Method vs. Net Method Chapter 7 -12 Payment terms are 2/10, n/30 LO 4 Explain accounting issues related to recognition of accounts receivable.

Recognition of Accounts Receivables Cash Discounts (Sales Discounts) Illustration 7 -4 Chapter 7 -13 LO 4 Explain accounting issues related to recognition of accounts receivable.

Recognition of Accounts Receivables E 7 -5: On June 3, Bolton Company sold to Arquette Company merchandise having a sale price of $2, 000 with terms of 2/10, n/60, f. o. b. shipping point. On June 12, the company received a check for the balance due from Arquette Company. Prepare the journal entries on Bolton Company books to record the sale assuming Bolton records sales using the gross method. June 3 Accounts receivable 2, 000 Sales June 12 Cash ($2, 000 x 98%) Sales discounts Accounts receivable Chapter 7 -14 2, 000 1, 960 40 2, 000 LO 4 Explain accounting issues related to recognition of accounts receivable.

Recognition of Accounts Receivables Nonrecognition of Interest Element A company should measure receivables in terms of their present value. The profession specifically excludes from present value considerations “receivables arising from transactions with customers in the normal course of business which are due in customary trade terms not exceeding approximately one year. ” Chapter 7 -15 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable How are these accounts presented on the Balance Sheet? Accounts Receivable Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Chapter 7 -16 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Chapter 7 -17 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Chapter 7 -18 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Journal entry for credit sale of $100? Accounts receivable 100 Sales Accounts Receivable 100 Allowance for Doubtful Accounts Beg. 500 25 Beg. End. 500 25 End. Chapter 7 -19 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Journal entry for credit sale of $100? Accounts receivable 100 Sales Accounts Receivable Beg. 500 Sale 100 End. 600 Chapter 7 -20 100 Allowance for Doubtful Accounts 25 Beg. 25 End. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Collected of $333 on account? Cash Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 600 Chapter 7 -21 333 Allowance for Doubtful Accounts 25 Beg. 25 End. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Collected of $333 on account? Cash Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 7 -22 333 333 Allowance for Doubtful Accounts 25 Beg. 25 End. Coll. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Adjustment of $15 for estimated Bad-Debts? Bad debt expense 15 Allowance for Doubtful Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 7 -23 333 15 Allowance for Doubtful Accounts 25 Beg. 25 End. Coll. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Adjustment of $15 for estimated Bad-Debts? Bad debt expense 15 Allowance for Doubtful Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 7 -24 333 Coll. 15 Allowance for Doubtful Accounts 25 Beg. 15 Est. 40 End. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. 267 Chapter 7 -25 333 Coll. 10 Allowance for Doubtful Accounts 25 Beg. 15 Est. 40 End. LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Write-off of uncollectible accounts for $10? Allowance for Doubtful accounts 10 Accounts receivable Accounts Receivable Beg. 500 Sale 100 End. Chapter 7 -26 257 333 Coll. 10 W/O 10 Allowance for Doubtful Accounts W/O 25 Beg. 15 Est. 30 End. 10 LO 4 Explain accounting issues related to recognition of accounts receivable.

Accounting for Accounts Receivable Chapter 7 -27 LO 4 Explain accounting issues related to recognition of accounts receivable.

Valuation of Accounts Receivable Reporting Receivables Classification Valuation (net realizable value) Uncollectible Accounts Receivable Sales on account raise the possibility of accounts not being collected. Chapter 7 -28 LO 5 Explain accounting issues related to valuation of accounts receivable.

Valuation of Accounts Receivable Uncollectible Accounts Receivable An uncollectible account receivable is a loss of revenue that requires, through proper entry in the accounts, Ø a decrease in the asset accounts receivable and Ø a related decrease in income and stockholders’ equity. Chapter 7 -29 LO 5 Explain accounting issues related to valuation of accounts receivable.

Valuation of Accounts Receivable Methods of Accounting for Uncollectible Accounts Direct Write-Off Theoretically undesirable: No matching Receivable not stated at net realizable value Not GAAP Chapter 7 -30 Allowance Method Losses are Estimated: Percentage-of-sales Percentage-ofreceivables GAAP LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Income Statement Approach Balance Sheet Approach Chapter 7 -31 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable Percentage-of-Sales Approach Illustration: Chad Shumway Corp. estimates from past experience that about 2 percent of credit sales become uncollectible. If Chad Shumway has credit sales of $400, 000 in 2010, it records bad debt expense as follows. Bad Debt Expense Allowance for Doubtful Accounts Chapter 7 -32 8, 000 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable What entry would Wilson make assuming that no balance existed in the allowance account? Bad Debt Expense Allowance for Doubtful Accounts Chapter 7 -33 37, 650 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable What entry would Wilson make assuming the allowance account had a credit balance of $800 before adjustment? Bad Debt Expense ($37, 650 – $800) Allowance for Doubtful Accounts Chapter 7 -34 36, 850 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry to record bad debt expense assuming Sandel Company estimates bad debts at (a) 1% of net sales and (b) 5% of accounts receivable. Chapter 7 -35 LO 5 Explain accounting issues related to valuation of accounts receivable.

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (a) 1% of net sales. Bad Debt Expense Allowance for Doubtful Accounts Chapter 7 -36 7, 500 ($800, 000 – $50, 000) x 1% = $7, 500 LO 5

Uncollectible Accounts Receivable E 7 -7 (Recording Bad Debts) Sandel Company reports the following financial information before adjustments. Instructions: Prepare the journal entry assuming Sandel estimates bad debts at (b) 5% of accounts receivable. Bad Debt Expense Allowance for Doubtful Accounts Chapter 7 -37 6, 000 ($160, 000 x 5%) – $2, 000) = $6, 000 LO 5

Uncollectible Accounts Receivable Summary Percentage of Sales approach: Bad debt expense estimate is related to a nominal account (Sales), any balance in the allowance account is ignored. Achieves a proper matching of cost and revenues. Percentage of Receivables approach: Results in a more accurate valuation of receivables on the balance sheet. Method may also be applied using an aging schedule. Chapter 7 -38 LO 5 Explain accounting issues related to valuation of accounts receivable.

Recognition of Notes Receivable Supported by a formal promissory note. A negotiable instrument Maker signs in favor of a Payee Interest-bearing (has a stated rate of interest) OR Zero-interest-bearing (interest included in face amount) Chapter 7 -39 LO 6 Explain accounting issues related to recognition of notes receivable.

Recognition of Notes Receivable Generally originate from: Customers who need to extend payment period of an outstanding receivable High-risk or new customers Loans to employees and subsidiaries Sales of property, plant, and equipment Lending transactions (the majority of notes) Chapter 7 -40 LO 6 Explain accounting issues related to recognition of notes receivable.

Recognition of Notes Receivable Chapter 7 -41 Short-Term Long-Term Record at Face Value, less allowance Record at Present Value of cash expected to be collected Interest Rates Note Issued at Stated rate = Market rate Face Value Stated rate > Market rate Premium Stated rate < Market rate Discount LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value Illustration: Bigelow Corp. lends Scandinavian Imports $10, 000 in exchange for a $10, 000, three-year note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is also 10 percent. How does Bigelow record the receipt of the note? i = 10% 0 Chapter 7 -42 $10, 000 Principal Interest $1, 000 1 2 3 n=3 4 LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value PV of Interest $1, 000 x Interest Received Chapter 7 -43 2. 48685 Factor = $2, 487 Present Value LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value PV of Principal $10, 000 Principal Chapter 7 -44 x . 75132 Factor = $7, 513 Present Value LO 6 Explain accounting issues related to recognition of notes receivable.

Note Issued at Face Value Summary Present value of interest $ 2, 487 Present value of principal 7, 513 Note current market value Notes receivable 10, 000 Cash Interest revenue Chapter 7 -45 $10, 000 1, 000 LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note Illustration: Jeremiah Company receives a three-year, $10, 000 zero-interest-bearing note. The market rate of interest for a note of similar risk is 9 percent. How does Jeremiah record the receipt of the note? i = 9% $10, 000 0 Chapter 7 -46 $0 $0 $0 1 3 3 n=3 Principal Interest 4 LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note PV of Principal $10, 000 Principal Chapter 7 -47 x . 77218 Factor = $7, 721. 80 Present Value LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note Illustration 7 -11 Chapter 7 -48 LO 6 Explain accounting issues related to recognition of notes receivable.

Zero-Interest-Bearing Note Journal Entries for Zero-Interest-Bearing note Present value of Principal Chapter 7 -49 $7, 721. 80 LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note Illustration: Morgan Corp. makes a loan to Marie Co. and receives in exchange a three-year, $10, 000 note bearing interest at 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. How does Morgan record the receipt of the note? i = 12% 0 Chapter 7 -50 $10, 000 Principal Interest $1, 000 1 2 3 n=3 4 LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note PV of Interest $1, 000 x Interest Received Chapter 7 -51 2. 40183 Factor = $2, 402 Present Value LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note PV of Principal $10, 000 Principal Chapter 7 -52 x . 71178 Factor = $7, 118 Present Value LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note Illustration: How does Morgan record the receipt of the note? Illustration 7 -13 Notes Receivable Discount on Notes Receivable Cash Chapter 7 -53 10, 000 480 9, 520 LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note Illustration 7 -14 Chapter 7 -54 LO 6 Explain accounting issues related to recognition of notes receivable.

Interest-Bearing Note Journal Entries for Interest-Bearing Note Cash Discount on notes receivable Interest revenue Chapter 7 -55 1, 000 142 1, 142 LO 6 Explain accounting issues related to recognition of notes receivable.

Recognition of Notes Receivable Notes Received for Property, Goods, or Services In a bargained transaction entered into at arm’s length, the stated interest rate is presumed to be fair unless: 1. No interest rate is stated, or 2. Stated interest rate is unreasonable, or 3. Face amount of the note is materially different from the current cash sales price. Chapter 7 -56 LO 6 Explain accounting issues related to recognition of notes receivable.

Recognition of Notes Receivable Illustration: Oasis Development Co. sold a corner lot to Rusty Pelican as a restaurant site. Oasis accepted in exchange a five -year note having a maturity value of $35, 247 and no stated interest rate. The land originally cost Oasis $14, 000. At the date of sale the land had a fair market value of $20, 000. Oasis uses the fair market value of the land, $20, 000, as the present value of the note. Oasis therefore records the sale as: ($35, 247 - $20, 000) = $15, 247 Notes Receivable Discount on Notes Receivable Land Gain on Sale of Land Chapter 7 -57 35, 247 14, 000 6, 000 LO 6 Explain accounting issues related to recognition of notes receivable.

Valuation of Notes Receivable Short-Term reported at Net Realizable Value (same as accounting for accounts receivable). Long-Term - FASB requires companies disclose not only their cost but also their fair value in the notes to the financial statements. Ø Fair Value Option. Companies have the option to use fair value as the basis of measurement in the financial statements. Chapter 7 -58 LO 7 Explain accounting issues related to valuation of notes receivable.

Valuation of Notes Receivable Illustration (recording fair value option): Assume that Escobar Company has notes receivable that have a fair value of $810, 000 and a carrying amount of $620, 000. Escobar decides on December 31, 2010, to use the fair value option for these receivables. This is the first valuation of these recently acquired receivables. At December 31, 2010, Escobar makes an adjusting entry to record the increase in value of Notes Receivable and to record the unrealized holding gain, as follows. Notes Receivable 190, 000 Unrealized Holding Gain or Loss—Income Chapter 7 -59 190, 000 LO 7 Explain accounting issues related to valuation of notes receivable.

Presentation and Analysis General rule in classifying receivables are: 1. Segregate the different types of receivables that a company possesses, if material. 2. Appropriately offset the valuation accounts against the proper receivable accounts. 3. Determine that receivables classified in the current assets section will be converted into cash within the year or the operating cycle, whichever is longer. 4. Disclose any loss contingencies that exist on the receivables. 5. Disclose any receivables designated or pledged as collateral. 6. Disclose all significant concentrations of credit risk arising from receivables. Chapter 7 -60 LO 9 Describe how to report and analyze receivables.

Presentation and Analysis of Receivables Illustration 7 -23 This Ratio used to: Assess the liquidity of the receivables. Measure the number of times, on average, a company collects receivables during the period. Chapter 7 -61 LO 9 Describe how to report and analyze receivables.

Ø The accounting and reporting related to cash is essentially the same under both i. GAAP and U. S. GAAP. Ø The basic accounting and reporting issues related to recognition and measurement of receivables are essentially the same between i. GAAP and U. S. GAAP. Ø Although i. GAAP implies that receivables with different characteristics should be reported separately, there is no standard that mandates this segregation. Chapter 7 -62

Ø The FASB, the IASB have adopted a piecemeal approach in which disclosure of fair value information in the notes is the first step. The second step is the fair value option. Ø i. GAAP and U. S. GAAP standards on the fair value option are similar but not identical. Ø i. GAAP and U. S. GAAP differ in the criteria used to derecognize a receivable. Chapter 7 -63

Management faces two problems in accounting for cash transactions: 1. establish proper controls to prevent any unauthorized transactions by officers or employees, and 2. provide information necessary to properly manage cash on hand cash transactions. Chapter 7 -64 LO 10 Explain common techniques employed to control cash.

Using Bank Accounts To obtain desired control objectives, a company can vary the number and location of banks and the types of accounts. Ø General checking account Ø Collection float. Ø Lockbox accounts Ø Imprest bank accounts Chapter 7 -65 LO 10 Explain common techniques employed to control cash.

Physical Protection of Cash Balances Company should Ø Minimize the cash on hand. Ø Only have on hand petty cash and current day’s receipts Ø Keep funds in a vault, safe, or locked cash drawer. Ø Transmit each day’s receipts to the bank as soon as practicable. Ø Periodically prove (reconcile) the balance shown in the general ledger. Chapter 7 -66 LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances Schedule explaining any differences between the bank’s and the company’s records of cash. Reconciling Items: 1. Deposits in transit. 2. Outstanding checks. 3. Bank charges and credits. Time Lags 4. Bank or Depositor errors. Chapter 7 -67 LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances Chapter 7 -68 Illustration 7 A-1 Bank Reconciliation Form and Content LO 10 Explain common techniques employed to control cash.

Reconciliation of Bank Balances Chapter 7 -69 LO 10 Explain common techniques employed to control cash.

Illustration 7 A-2 Chapter 7 -70 LO 10 Explain common techniques employed to control cash.

Illustration: Journalize the adjusting entries at November 30 on the books of Nugget Mining Company. Nov. 30 Cash 542 Office expense Accounts receivable Chapter 7 -71 18 220 Accounts payable 180 Interest revenue 600 LO 10 Explain common techniques employed to control cash.

Review Question The reconciling item in a bank reconciliation that will result in an adjusting entry by the depositor is: a. outstanding checks. b. deposit in transit. c. a bank error. d. bank service charges. Chapter 7 -72 LO 10 Explain common techniques employed to control cash.

Companies evaluate their receivables to determine their ultimate collectibility. Allowance method is appropriate when: ü probable that an asset has been impaired and ü amount of the loss can be reasonably estimated. Long-term receivables such as loans that are identified as impaired, companies perform an additional impairment evaluation. Chapter 7 -73 LO 11 Describe the accounting for a loan impairment.

Background - Example: Subprime loan crisis. ü From 2000 to 2005 home prices appreciated at rapid rate. ü Low interest rates also encouraged speculation, as many believed that home prices would continue to increase. ü Speculators intended to sell the house in a short period. ü Many adjustable-rate debt with short-term low teaser rates that would adjust to higher market rates after two or three years. ü Many lending institutions gave loans to individuals whose financial condition would make it difficult for them to make the payments over the life of the loan. These loans, often referred to as subprime loans. Chapter 7 -74 LO 11 Describe the accounting for a loan impairment.

Background - Example: Subprime loan crisis. Illustration 7 B-1 Subprime lending was a little over $50 billion in 2000 and had increased almost ten times by 2005. Chapter 7 -75 LO 11 Describe the accounting for a loan impairment.

Background - Example: Subprime loan crisis. Illustration 7 B-2 Beyond the subprime loans was the practice of securitization. Chapter 7 -76 LO 11 Describe the accounting for a loan impairment.

Impairment Measurement and Reporting Impairment loss is calculated as the difference between Ø the investment in the loan (generally the principal plus accrued interest) and Ø the expected future cash flows discounted at the loan’s historical effective interest rate. Chapter 7 -77 LO 11 Describe the accounting for a loan impairment.

Illustration: At December 31, 2009, Ogden Bank recorded an investment of $100, 000 in a loan to Carl King. The loan has an historical effective-interest rate of 10 percent, the principal is due in full at maturity in three years, and interest is due annually. The loan officer performs a review of the loan’s expected future cash flow and utilizes the present value method for measuring the required impairment loss. Illustration 7 B-3 Chapter 7 -78 LO 11 Describe the accounting for a loan impairment.

Illustration: Computation of Impairment Loss Illustration 7 B-4 Recording Impairment Losses Bad Debt Expense 12, 437 Allowance for Doubtful Accounts Chapter 7 -79 12, 437 LO 11 Describe the accounting for a loan impairment.

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