LongTerm Notes Receivables Longterm notes are valued at
Long-Term Notes Receivables • Long-term notes are valued at the present value of cash expected in the future. • The relationship between the face value and the present value of the notes is dependent on the relationship between the stated (or contractual) interest rate and the market (or effective) interest rate. • Stated rate = Market rate means Face value = Present value – Interest-bearing – Zero-interest-bearing 1
Long-term Note for Cash (Stated rate = Market rate): Jeremiah Co. receives a $10, 000, 3 -year, 10% note. The market rate for a note of similar risk is also 10%. What is the present value? What are the appropriate journal entries? How does the effective interest method of interest revenue recognition work? Face (Contractual) value of the note $10, 000 Present value of the principal amount of the note: $7, 513 $10, 000 (PVF 3, 10%) = $10, 000 X. 75132 Present value of the annual interest receipts: $1, 000 (PVF-OA 3, 10%) = 1, 000 X 2. 48685 $2, 487 $10, 000 Present value of the note: Difference Receipt of the Note: Notes Receivable Cash Interest earned for the next two years: Cash Interest Revenue ($10, 000 X 10% X 12/12) Payment of Note and Interest in year three: Cash Notes Receivable Interest Revenue $0 10, 000 1, 000 11, 000 10, 000 1, 000 2
Long-term Note for Cash (Stated rate = Market rate): Jeremiah Co. receives a $10, 000, 3 -year, 10% note. The market rate for a note of similar risk is 12%. Face (Contractual) of the noteof Market Interest: Effective value Interest Method Note Discount Amortization$10, 000 Interest Beg. Present Balance, Stated Interest: value of the principal amount of the note: Difference: 1 Note - PV Cash Revenue 2 Discount 3 $7, 118 $10, 000 (PVF 3, 12%) = $10, 000 X. 71178 9, 520 1, 000 1, 142 Present the annual interest receipts: 9, 662 value of 1, 000 1, 159 9, 821 1, 000 179 $2, 402 $1, 000 (PVF-OA 3, 12%) = 1, 000 1, 179 X 2. 40183 Stated Interest = 10, 000 X 10% Present value of the. Value note: X 12% Market Interest = Present 3 Difference = Stated Interest – Market Interest Difference 1 $ 9, 520 2 Receipt of the Note: Notes Receivable Discount on Notes Receivable Cash Interest earned for the next year: Cash Discount on Notes Receivable Interest Revenue ($9, 520 X 12% X 12/12) Payment of Note and Interest in year three: Cash Discount on Notes Receivable Interest Revenue End. Balance, Note - PV 9, 662 9, 821 10, 000 $ 480 10, 000 480 9, 520 1, 000 142 1, 142 11, 000 179 10, 000 1, 179 3
Long-term Note for Cash (Stated rate = Market rate): In exchange for $7, 721. 80, Jeremiah Co. receives a $10, 000, 3 -year, zero-interestbearing note. 7, 721. 80 What is the Market Rate? 10, 000. 00 Face (Contractual) of the note of Market Interest: Effectivevalue Interest Method Note Discount Amortization$10, 000 PVF (3, 0. 77218) = 9% Interest Beg. Balance, Stated End. Balance, Present value of the. Interest: principal amount of the note: Difference: 1 2 3 Note - PV Cash Revenue Discount Note - PV $7, 721. 80. 77218 $10, 000 (PVF 3, ? ) = $10, 000 X 7, 721. 80 694. 96 8, 416. 76 -0 Present receipts: 8, 416. 76 value of the -0 -annual interest 757. 51 9, 174. 27 -0825. 73 10, 000. 00 825. 73 $ 0 $1, 000 (PVF-OA 3, ? ) = 0 X 1 Stated Interest = $10, 000 X 0% Present value of the note: Market Interest = Present Value X 9% 3 Difference = Stated Interest – Market Interest $ 7, 721. 80 2 Difference Receipt of the Note: Notes Receivable Discount on Notes Receivable Cash Interest earned for the next year: Discount on Notes Receivable Interest Revenue Payment of Note in year three: Cash Discount on Notes Receivable Interest Revenue $ 2, 278. 20 10, 000. 00 2, 278. 20 7, 721. 80 694. 96 10, 000. 00 825. 73 4
Notes Receivables • For materiality purposes, short-term notes are generally recorded at face value (less an allowance account). • Notes issued for property, goods, or services are assumed to be fairly stated at the contractual rate, unless: – There is no interest rate stated. – The rate stated is unreasonable. – The contractual value is different from the fair value of either the goods purchased or the debt instrument employed. 5
Note in a Sale: SWSH manufactures athletic shoes that it sells to retailers. On 5 -1 -04, 8 -1 -04, the company sold shoes to HSG Sports. SWSH agreed to accept a $700, 000, 6 -month, 12% note for the shoes. Interest is payable at maturity. This transactions should be accounted for as follows: 5/1/04 8/1/04 Notes Receivable Sales 11/1/05 12/31/04 Cash Interest Receivable Notes Receivable Interest Revenue ($700, 000 X 12% X 5/12) ($700, 000 X 12% X 6/12) 2/1/05 Cash Notes Receivable Interest Revenue ($700, 000 X 12% X 1/12) 700, 000 742, 000 35, 000 700, 000 35, 000 42, 000 700, 000 35, 000 7, 000 6
Zero-interest-bearing Note for Sale: Oasis Co. sold a lot to Rusty Pelican as a restaurant site and accepted a 5 -year note with a maturity value of $35, 247 and no stated interest rate. The land originally cost Oasis $14, 000 and at the date of sale had an appraisal value of $20, 000: Notes Receivable Land Gain on Sale of Land (20, 000 -14, 000) Discount on Notes Receivable (35, 247 – 20, 000) $35, 247 14, 000 6, 000 15, 247 Market of Interest: Effective Interest Method Note Discount Amortization Interest Beg. Balance, Stated Interest: Difference: End. Balance, 1 2 3 Note - PV Cash Revenue Discount Note - PV 20, 000 -02, 400 22, 400 -02, 688 25, 088 -03, 011 28, 099 -03, 372 31, 471 -03, 776 35, 247 Stated Interest = 35, 247 X 0% Market Interest = Present Value X 12% 3 Difference = Stated Interest – Market Interest 1 2 7
Accounts Receivables • Adjustments: – Sales Returns & Allowances – Sales Discounts • Valuation – Net Realizable Value • Percentage of Sales • Percentage of Receivables • Disposition – Secured Borrowing – Factoring/Securitization • Without Recourse • With Recourse 8
Accounts Receivable Adjustments: Sales Discounts Sales (Cash) Discounts: Company A offers credit customers a 2% cash discount if the sales price is paid within 10 days. Any amounts not paid within 10 days are due in 30 days. These repayment terms are stated as 2/10, n/30. On 10 -5 -03, Co. A sold merchandise at a price of $20, 000. The customer paid $13, 720 ($14, 000 less the 2% cash discount) on 10 -14 and the remaining balance of $6, 000 on 11 -4. Net Method: Gross Method: October 5 Accounts Receivable Sales 20, 000 19, 600 20, 000 October 14 Cash 13, 720 Accounts Receivable Sales Discount 280 Accounts Receivable 13, 720 14, 000 November 4 Cash 6, 000 Accounts Receivable Sales Discount Forfeited 5, 880 6, 000 120 9
Accounts Receivable Adjustments: Sales Returns & Allowances Sales Returns: In 2003, Company A sold merchandise on account for $2, 000. This merchandise cost $1, 200, 000 (60% of the selling price). Industry experience indicates that 10% of all sales will be returned. Customers returned $130, 000 in sales during 2003, prior to making payment. Sale: Accounts Receivable Sales 2, 000 Cost of goods sold (60% X $130, 000) Inventory 1, 200, 000 2, 000 1, 200, 000 Return Sales Returns (actual) 130, 000 Accounts Receivable Inventory 130, 000 78, 000 Cost of goods sold (60%) 78, 000 Adjusting entries Sales Returns ([10% X $2, 000] – 130, 000) Allowance for sales returns 70, 000 Inventory 42, 000 Cost of goods sold (60%) 70, 000 42, 000 10
Accounts Receivable Valuation: Percentage of Sales BRIEF EXERCISE 7 -4 Battle Tank had net sales in 2004 of $1, 200, 000. At December 31, 2004, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250, 000 debit, and Allowance for Doubtful Accounts $2, 100 credit. If battle Tank estimates that 2% of net sales will prove to be uncollectible, prepare the December 31, 2004, journal entry to record bad debt expense. Bad Debt Expense Allowance for Doubtful Accounts ($1, 200, 000 X 2% = $24, 000) 24, 000 11
Accounts Receivable Valuation: Percentage of A/R BRIEF EXERCISE 7 -5 Battle Tank had net sales in 2004 of $1, 200, 000. At December 31, 2004, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250, 000 debit, and Allowance for Doubtful Accounts $2, 100 credit. If battle Tank estimates that 10% of accounts receivable will prove to be uncollectible, prepare the December 31, 2004, journal entry to record bad debt expense. (a) Bad Debt Expense 22, 900 Allowance for Doubtful Accounts 22, 900 [(10% X $250, 000) – $2, 100] Battle Tank had net sales in 2004 of $1, 200, 000. At December 31, 2004, before adjusting entries, the balances in selected accounts were: Accounts Receivable $250, 000 debit, and Allowance for Doubtful Accounts $2, 100 credit. If battle Tank estimates, based on an aging of accounts receivable, that $24, 600 of accounts will prove to be uncollectible, prepare the December 31, 2004, journal entry to record bad debt expense. (b) Bad Debt Expense Allowance for Doubtful Accounts ($24, 600 – $2, 100) 22, 500 12
Accounts Receivable Valuation: Additional Issues Writing off an account: Battle Tank receives notice from Client Company A, who owes Battle $1, 500, that it has declared bankruptcy and does not have the means to pay Ace the amount owed. Allowance for Doubtful Accounts 1, 500 Accounts Receivable 1, 500 Note that this transaction does not change the Subsequent payment for a written off account: net realizable value of accounts receivable. Several months later, Battle Tank receives $750 from a bankruptcy settlement relating to Client Company A. Accounts Receivable 750 Allowance for Doubtful Accounts Cash 750 Accounts Receivable 750 13
Accounts Receivable Disposal: Secured Borrowing & Factoring Secured Borrowing (BE 7 -8) On 10 -1 -04, Akira assigns $1, 000 of its accounts receivable to Alisia Bank as collateral for a $700, 000 note. The bank assesses a finance charge of 2% of the receivable assigned and interest on the note of 13%. Prepare the 10 -1 journal entries for both Akira and Alisia. Akira, Inc. Cash Finance Charge Notes Payable 680, 000 20, 000 700, 000 Alisia National Bank Notes Receivable Cash Financing Revenue 700, 000 680, 000 20, 000 14
Factoring Without Recourse (BE 7 -9) CRC factored $100, 000 of accounts receivable with FF on a WITHOUT RECOURSE basis. FF assesses a 2% finance charge of the amount of accounts receivable and retains an amount equal to 6% of accounts receivable for possible adjustments. Prepare the journal entry for CRC and FF to record the factoring of the accounts receivable to FF. CRC Fredrick 92, 000 Cash Due from Factor Loss on Sale of Receivables Accounts Receivable 6, 000* 2, 000** 100, 000 Accounts Receivable 100, 000 Due to CRC 6, 000 Financing Revenue 2, 000 92, 000 Cash *6% X $100, 000 = $6, 000 **2% X $100, 000 = $2, 000 Factoring With Recourse (BE 7 -10) CRC factored $100, 000 of accounts receivable with FF on a WITH RECOURSE basis. FF assesses a 2% finance charge of the amount of accounts receivable and retains an amount equal to 6% of accounts receivable for possible adjustments. The recourse obligation has a fair value of $7, 500. Prepare the journal entry for CRC and FF to record the factoring of the accounts receivable to FF. CRC Fredrick Accounts Receivable Due to CRC Financing Revenue Cash 92, 000 Cash Due from Factor 6, 000* Loss on Sale of Receivables 9, 500** Accounts Receivable 100, 000 Recourse Obligation 7, 500 100, 000 6, 000 2, 000 92, 000 *6% X $100, 000 = $6, 000 **2% X $100, 000 = $2, 000 + $7, 500 15
Classification of Cash, Cash Equivalents, and Noncash Items Item Classification Comment If unrestricted, report as cash. Cash Petty cash and change funds Cash Short-term paper Cash equivalents Investments with maturity of less than 3 months. Short-term paper Temporary Investments with maturity of 3 to 12 months. Postdated Checks and IOU's Receivables Assumed to be collectible. Travel Advances Receivables Assumed to be collected from employees or deducted from their salaries. Postage on hand Prepaid expense May also be classified as office supplies. Bank overdrafts Current liability Compensating balances Cash separately classified as a deposit maintained as a compensating balance If restricted, identify and classify as current or noncurrent asset. If right of offset exists, reduce cash Classify as current or noncurrent in the balance sheet. Disclose separately in notes details of the arrangement. 16
EXERCISE 7 -18 (10 -15 minutes) 1. 2. 7/1/04 Notes Receivable Discount on Notes Receivable Land Gain on Sale of Land [($700, 000 – $590, 000) $1, 101, 460 X. 63552 $ 700, 000 1, 101, 460 $ 401, 460 Notes Receivable Discount on Notes Receivable Service Revenue Computation of the present value of the note: Maturity value Present value of $400, 000 due in 8 years at 12%—$400, 000 X. 40388 Present value of $12, 000 payable annually for 8 years at 12% annually—$12, 000 X 4. 96764 Present value of the note and interest Discount 1, 101, 460. 00 401, 460. 00 590, 000. 00 110, 000. 00 Face value of note Present value of 1 for 4 periods at 12% Present value of note Face value of note Discount on note receivable 400, 000. 00 178, 836. 32 221, 163. 68 400, 000. 00 $161, 552. 00 59, 611. 68 221, 163. 68 $178, 836. 32 17
EXERCISE 7 -19 (20 -25 minutes) (a) Notes Receivable Discount on Notes Receivable Consulting Revenue 200, 000 48, 772 151, 228* *Computation of present value of note: PV of $200, 000 due in 2 years at 15% $200, 000 X. 75614 = $151, 228 (b) Discount on Notes Receivable Interest Revenue 22, 684. 20* *$151, 228 X 15% = $22, 684. 20 (c) Discount on Notes Receivable Interest Revenue 26, 087. 80* 26, 087. 80 *$48, 772. 00 – $22, 684. 20 Cash 200, 000 Notes Receivable 200, 000 18
PROBLEM 7 -9 December 31, 2004 (a) Cash Notes Receivable Discount on Notes Receivable Revenue from Services To record revenue at the present value of the note plus the immediate cash payment: PV of $18, 000 annuity @ 11% for 4 years ($18, 000 X 3. 10245) Down payment Capitalized value of services 36, 000. 00 72, 000. 00 16, 155. 90 91, 844. 10 $55, 844. 10 36, 000. 00 $91, 844. 10 19
PROBLEM 7 -9 (Cont. ) December 31, 2005 (b) Cash 18, 000. 00 Notes Receivable Discount on Notes Receivable Interest Revenue 18, 000. 00 6, 142. 85 Schedule of Note Discount Amortization Date 12/31/04 12/31/05 12/31/06 12/31/07 12/31/08 Totals Debit, Discount on Notes Receivable/ Credit, Interest Revenue Installment Paid — $6, 142. 85 a 4, 838. 56 3, 390. 81 1, 783. 68 c 16, 115. 90 — $18, 000. 00 72, 000. 00 Present Value of Note $55, 844. 10 43, 986. 95 b 30, 825. 51 16, 216. 32 — a$6, 142. 85 = $55, 844. 10 X 11% = $55, 844. 10 + $6, 142. 85 – $18, 000. 00 c. Rounded by $. 12 b$43, 986. 95 20
December 31, 2006 (c) Cash 18, 000. 00 Notes Receivable Discount on Notes Receivable Interest Revenue 4, 838. 56 18, 000. 00 4, 838. 56 December 31, 2007 (d) Cash 18, 000. 00 Notes Receivable Discount on Notes Receivable Interest Revenue 3, 390. 81 18, 000. 00 3, 390. 81 December 31, 2008 (e) Cash Notes Receivable Discount on Notes Receivable Interest Revenue 18, 000. 00 1, 783. 68 21
PROBLEM 7 -2 1. Net Sales Percentage Bad debt expense $1, 500, 000 1 1/2% $22, 500 2. Accounts receivable Amounts estimated to be uncollectible Net realizable value $1, 750, 000 (180, 000) $1, 570, 000 3. Allowance for doubtful accounts 1/1/03 Establishment of accounts written off in prior years Customer accounts written off in 2003 Bad debt expense for 2003 ($2, 100, 000 X 3%) Allowance for doubtful accounts 12/31/03 $17, 000 8, 000 (30, 000) 63, 000 $58, 000 4. Bad debt expense for 2003 Customer accounts written off as uncollectible during 2003 Allowance for doubtful accounts balance 12/31/03 $84, 000 (24, 000) $60, 000 5. Accounts receivable, net of allowance for doubtful accounts Allowance for doubtful accounts balance 12/31/03 Accounts receivable, before deducting allowance for doubtful accounts Accounts receivable Percentage Bad debt expense, before adjustment Allowance for doubtful accounts (debit balance) Bad debt expense, as adjusted $950, 000 60, 000 $1, 010, 000 $410, 000 3% 12, 300 14, 000 $ 26, 300 22
PROBLEM 7 -3 (a)The Allowance for Doubtful Accounts should have a balance of $50, 000 at year-end. The supporting calculations are shown below: Expected Days Account Estimated Amount Percentage Outstanding Uncollectible 0 -15 days 16 -30 days 31 -45 days $300, 000 100, 000 80, 000 . 02. 10. 15 46 -60 days 40, 000. 25 61 -75 days 20, 000. 60 Balance for Allowance for Doubtful Accounts $ 6, 000 10, 000 12, 000 $50, 000 The accounts which have been outstanding over 75 days ($15, 000) and have zero probability of collection would be written off immediately and not be considered when determining the proper amount for the Allowance for Doubtful Accounts. (b) Accounts receivable Less: Allowance for doubtful accounts Accounts receivable (net) $540, 000 50, 000 $490, 000 (c) The year-end bad debt adjustment would decrease before-tax income $30, 000 as computed below: Estimated amount required in the Allowance for Doubtful Accounts $50, 000 Balance in the account after write-off of uncollectible accounts but before adjustment ($35, 000 – $15, 000) 20, 000 Required charge to expense $30, 000 23
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