Cash and Receivables Chapter 7. Learning Objectives 1. Define internal control and describe some key elements of an internal control system for cash receipts.

Cash and Receivables

Chapter 7

Learning Objectives

Cash and Cash Equivalents

Balances inchecking accounts

Balances inchecking accounts

Currency and coinsCurrency and coins

Cash equivalents are short-term, highly liquid investments that can be readily converted to cash.

Cash equivalents are short-term, highly liquid investments that can be readily converted to cash.

Money marketfunds

Money marketfunds Treasury billsTreasury bills Commercial

paperCommercial

paper

CashCash

Items for deposit such as checks and money orders

from customers

Items for deposit such as checks and money orders

from customers

Cash and Cash EquivalentsCash

Currency, coins and amounts on deposit in bank accounts: checking accounts, and many savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders.

Cash Currency, coins and amounts on deposit in bank

accounts: checking accounts, and many savings accounts. Also includes items such as customer checks, cashier checks, certified checks, and money orders.

Cash Equivalents

Short-term, highly liquid investments that are:

1. Readily convertible to a known cash amount.

2. That have an original maturity date of three months or less from the date of purchase

3. US Treasury Bills & Notes: 3-month maturity.

4. 3-month CDs and Money Market Funds

Cash Equivalents

Short-term, highly liquid investments that are:

1. Readily convertible to a known cash amount.

2. That have an original maturity date of three months or less from the date of purchase

3. US Treasury Bills & Notes: 3-month maturity.

4. 3-month CDs and Money Market Funds6-4

Cash & Cash Equivalents

On Dec. 31, 2010, ABC Co's total CASH COUNT= $1,000,000

The following items are included in the CASH COUNT: Petty cash funds=$12,000, Customers Checks =$3,000, Coins =$1,000 and Stamps =$100.

The following items are not included in cash count: -Three-month CD: $10,000 -Two-month Treasury Note (Bill): $7,000

Required:Prepare the Current Assets Section of the Balance

Sheet

Restricted Cash andCompensating Balances

Restricted CashManagement’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt.

Compensating BalanceMinimum balance that must bemaintained in a company’s bankaccount as support for fundsborrowed from the bank.

Restricted CashManagement’s intent to use a certain amountof cash for a specific purpose – future plant expansion, future payment of debt.

Compensating BalanceMinimum balance that must bemaintained in a company’s bankaccount as support for fundsborrowed from the bank.

Cash & Cash Equivalents, Restricted Cash and Compensating Balances

Exercise 7–1


Exercise 7–1:

Requirement 1

a. Balance in checking account $13,500Balance in savings account 22,100

b. Un-deposited customer checks 5,200c. Currency and coins on hand 580f. U.S. treasury bills with 2-month maturity 15,000

Total $56,380Requirement 2d. The $400,000 savings account will be used for future plant expansion and therefore should be classified as a noncurrent asset, either in investments & Funds. e. The $20,000 in the checking account is a compensating balance for a long-term loan and should be classified as a noncurrent asset, either in investments & Funds. f. The $20,000 in 7-month treasury bills should be classified as a current asset along with other temporary investments.


RED WING CORPORATIONPartial Balance Sheet

As of December 31, 2013

Current Assets: Cash and cash equivalents $56,380 Marketable Securities 20,000

Investments and Funds: Plant Expansion Fund 400,000 Loan Compensating Fund 20,000

U.S. GAAP vs. IFRS

Bank overdrafts are treated as liabilities.

In general, cash and cash equivalents aretreated similarly under IFRS and U.S. GAAP. One difference

is highlighted below.

Bank overdrafts may be offset against other cash accounts.

Exercise 4

Internal Control (SELF-STUDY)

Encourages adherence to company policiesand procedures

Encourages adherence to company policiesand procedures

Promotes operational efficiency

Promotes operational efficiency

Minimizes errorsand theft

Minimizes errorsand theft

Enhances the reliability and accuracy of accounting dataEnhances the reliability and accuracy of accounting data

Internal Control Procedures (SELF-STUDY)

Cash Receipts Separate responsibilities for receiving cash, recording

cash transactions, and reconciling cash balances. Match the amount of cash received with the amount

of cash deposited. Close supervision of cash-handling and cash-

recording activities.

Cash Receipts Separate responsibilities for receiving cash, recording

cash transactions, and reconciling cash balances. Match the amount of cash received with the amount

of cash deposited. Close supervision of cash-handling and cash-

recording activities.

Cash Disbursements All disbursements, except petty cash, made by

check. Separate responsibilities for cash disbursement

documents, check authorization, check signing, and record keeping.

Checks should be signed only by authorized individuals.

Cash Disbursements All disbursements, except petty cash, made by

check. Separate responsibilities for cash disbursement

documents, check authorization, check signing, and record keeping.

Checks should be signed only by authorized individuals.

Internal Control Procedures

PETTY CASH ACCOUNTINGPETTY CASH ACCOUNTING

BANK RECONCILIATIONBANK RECONCILIATION

Petty cash is used for minor expenditures.

Has one custodian.

Replenished periodically.

Petty cash fund

Appendix 7-A: Cash Controls

Petty Cash System of Control

Small payments required in most companies for items such as postage, courier fees, repairs and supplies.

Internal Control requires that companies pay for these small amounts from Petty Cash Fund.

Small payments required in most companies for items such as postage, courier fees, repairs and supplies.

Internal Control requires that companies pay for these small amounts from Petty Cash Fund.

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Operating a Petty Cash Fund

Petty Cash

CompanyCompanyCashierCashier

Petty Petty CashierCashier

May 1 Petty cash 400 Cash 400

AccountantAccountant

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Petty Cash



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39¢

Stamps$45

Courier$80



A petty cash fund is used only

for business expenses.

A petty cash fund is used only

for business expenses.

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Receipts

Petty cash receipts with

either no signature or a

forged signature usually indicate misuse of petty

cash.

Petty cash receipts with

either no signature or a

forged signature usually indicate misuse of petty

cash.


39¢

Stamps$45

Courier$80

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Receipts

Company Company CashierCashier

$125To reimburse

petty cash fund

Use a CashOver and Short

account if needed.

Use a CashOver and Short

account if needed.



May 31 Postage expense 45 Delivery expense 80

Cash 125

AccountantAccountant

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Sometimes, the petty cash receipts plus the cash remaining will not total to the fund balance.

i. A shortage is recorded as an expense in the reimbursing entry with a debit to the Cash Over and Short account.

ii. An overage is recorded with a credit to the Cash Over and Short account in the reimbursing entry.

Petty Cash Example

Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July:

Travel Expenses $79.30

Customer Business Lunches 93.42

Express Mail Postage 55.00

Miscellaneous Office Supplies 32.48 $260.20

Let’s look at replenishing the fund if the

Cash Balance on July 31 was $137.80.

Tension Co. maintains a petty cash fund of $400. The following summary information was taken from petty cash vouchers for July:

Travel Expenses $79.30

Customer Business Lunches 93.42

Express Mail Postage 55.00

Miscellaneous Office Supplies 32.48 $260.20

Let’s look at replenishing the fund if the

Cash Balance on July 31 was $137.80.

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Petty Cash Example

What amount of cash will be required to replenish the petty cash fund?

a. $260.20b. $262.20c. $139.80d. $137.80


a. $260.20b. $262.20c. $139.80d. $137.80

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Petty Cash Example


a. $260.20

b. $262.20

c. $139.80

d. $137.80


a. $260.20

b. $262.20

c. $139.80

d. $137.80

Let’s prepare the journal entry to replenish the petty cash fund.

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Petty Cash Example

Dr. Cr.

Travel Expense 79.30

Entertainment Expense 93.42

Postage Expense 55.00

Office Supplies Expense 32.48

Cash Over and Short 2.00

Cash 262.20

July 31

Journal entry to replenish petty cash fund

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EXERCISE 26, 27

Appendix 7-A: Cash Controls

Bank Balance

+ Deposits in Transit

- Outstanding Checks

± Bank Errors

= Corrected Balance

Book Balance

+ Bank Collections

- Service Charges - NSF Checks

± Book Errors

= Corrected Balance

A bank reconciliation explains the difference between cash reported on bank statement and cash balance on a company’s books.

Bank StatementOnce a month, the bank sends each depositor a bank statement showing activities of a bank account.

A bank statement includes, at least, the following:1.Beginning cash balance per bank;

2.Check & other debits decreasing the balance;

3.Deposits & other credits increasing the balance;

4.Ending cash balance per bank.

First National BankNashville, TN 37459 May 31, 2009

Clothes MartNashville, TN

Acct No 278609

Previous Balance Total Checks

Total Deposits

Current Balance

1488.79 1,367.09 2,604.22 2,725.92

5/1 107 55.00

5/2 1,251.88

5/4 108 279.50

5/7 109 44.75

5/9 110 21.81

5/12 111 37.55

5/15 825.04

5/18 112 175.98

5/21 113 288.31

5/27 114 12.54

5/30 527.30

5/31 115 451.65

Bank Statement

Bank Reconciliation A bank reconciliation is prepared

periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books.

A bank reconciliation is prepared periodically to explain the difference between cash reported on the bank statement and the cash balance on company’s books.

First National BankNashville, TN 37459 May 31, 2009

Clothes MartNashville, TN

Acct No 278609

Previous Balance Total Checks

Total Deposits

Current Balance

1488.79 1,367.09 2,604.22 2,725.92

5/1 107 55.00

5/2 1,251.88

5/4 108 279.50

5/7 109 44.75

5/9 110 21.81

5/12 111 37.55

5/15 825.04

5/18 112 175.98

5/21 113 288.31

5/27 114 12.54

5/30 527.30

5/31 115 451.65

Bank Statement

Why are thebalances different?

Why are thebalances different?*

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Reconciling Items

Bank Statement Balance

Add: Deposits in transit.Deduct: Outstanding

ChecksAdd or Deduct: Bank

errors.Adjusted Bank Balance

Bank Statement Balance

Add: Deposits in transit.Deduct: Outstanding

ChecksAdd or Deduct: Bank

errors.Adjusted Bank Balance

Book Balance• Add: Collections made by

the bank.• Add: Interest earned on

checking account. =>CM• Deduct: Nonsufficient

funds check (NSF).• Deduct: Bank service

charge =>DM• Add or Deduct:

Book errorsAdjusted Book Balance.

Book Balance• Add: Collections made by

the bank.• Add: Interest earned on

checking account. =>CM• Deduct: Nonsufficient

funds check (NSF).• Deduct: Bank service

charge =>DM• Add or Deduct:

Book errorsAdjusted Book Balance.

6-31

Reconciling Items

Identify and list any unrecorded Debit Memoranda (DM) from the bank for NSF Checks, service charges, and errors over stating the book balance. => Deduct them from the book balance. Identify and list any unrecorded Credit Memoranda (CM) from the bank for interest, collections, and errors under stating the book balance. => Add them to the book balance.

Bank Reconciliation

Two sections:1. Reconcile bank statement balance to the

adjusted bank balance.2. Reconcile book balance to the

adjusted book balance.

The adjusted balances should be equal.

Two sections:1. Reconcile bank statement balance to the

adjusted bank balance.2. Reconcile book balance to the

adjusted book balance.

The adjusted balances should be equal.

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Bank Reconciliation Example

Let’s prepare a July 31 bank reconciliation statement for the Simmons Company.

The July 31 bank statement indicated a balance of $9,610.

The cash general ledger account on that date shows a balance of $7,430.

Additional information necessary for the reconciliation is shown on the next

screen.

Let’s prepare a July 31 bank reconciliation statement for the Simmons Company.

The July 31 bank statement indicated a balance of $9,610.

The cash general ledger account on that date shows a balance of $7,430.

Additional information necessary for the reconciliation is shown on the next

screen.

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Bank Reconciliation Example

1. Outstanding checks totaled $2,417.

2. A $500 check mailed to the bank for deposit had not reached the bank at the statement date.

3. The bank returned a customer’s NSF check for $225 received as payment on account receivable.

4. The bank statement showed $30 interest earned during July.

5. Check No. 781 for supplies expense cleared the bank for $268 but was erroneously recorded in our books as $240.

6. A $486 deposit by Acme Company was erroneously credited to our account by the bank.

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Bank Reconciliation ExampleP3

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Dr. Cr.July 31 Cash 30

Interest revenue 30

July 31 Supplies expense 28 Accounts receivable 225

Cash 253

Recording Adjusting Entries from a Bank

Reconciliation

Only amounts shown on the book portion of the reconciliation require an adjusting entry.

Only amounts shown on the book portion of the reconciliation require an adjusting entry.

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Recording Adjusting Entries from a Bank Reconciliation

After posting the reconciling entries the cash account looks like this:

After posting the reconciling entries the cash account looks like this:

Adjusted balance on July 31.Adjusted balance on July 31.

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Exercises 28, 29

Accounts Receivable

Result from the credit sales of

goods or services to customers.

Are classified as current assets.

Are recorded net of trade discounts.

Trade Discounts

Used by manufacturers and wholesalers to offer Used by manufacturers and wholesalers to offer better prices for greater quantities purchased.better prices for greater quantities purchased.

ExampleExampleMatrix, Inc. offers a 30% tradeMatrix, Inc. offers a 30% tradediscount on orders of 1,000discount on orders of 1,000

units or more of their popularunits or more of their popularproduct Racer. Each product Racer. Each

Racer has a list price of $5.25.Racer has a list price of $5.25.

ExampleExampleMatrix, Inc. offers a 30% tradeMatrix, Inc. offers a 30% tradediscount on orders of 1,000discount on orders of 1,000

units or more of their popularunits or more of their popularproduct Racer. Each product Racer. Each

Racer has a list price of $5.25.Racer has a list price of $5.25.

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Cash discountsCash discounts

Cash (Sales) Discounts


A deduction from the invoice price granted to induce early payment of the amount due.

A deduction from the invoice price granted to induce early payment of the amount due.

Terms

Time

Due

Discount Period

Due: Invoice price minus

discount

Credit Period

Due: Full Invoice Price

Date of Date of InvoiceInvoice

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2/10,n/302/10,n/30Number of

days discount is available

Number of days

discount is available

Otherwise, net (or all)

is due

Otherwise, net (or all)

is due

CreditperiodCreditperiod

Discount percent

Discount percent


When Discount is Not Taken

If we fail to take a 2/10, n/30 discount, is it really expensive?

If we fail to take a 2/10, n/30 discount, is it really expensive?

365 days ÷ 20 days × 2% = 36.5% annual rate 365 days ÷ 20 days × 2% = 36.5% annual rate

Daysin ayear

Daysin ayear

Numberof additionaldays before

payment

Numberof additionaldays before

payment

Percentpaid to keep

money

Percentpaid to keep

money

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Sales are recorded at the invoice

amounts.

Sales are recorded at the invoice

amounts.

Sales discounts are recorded as reduction of

revenue if payment is received within the discount period.

Sales discounts are recorded as reduction of

revenue if payment is received within the discount period.

Gross Method


On October 5, Hawthorne sold merchandise for $20,000 with terms 2/10, n/30. On October 14, the customer sent a check for $13,720 taking advantage of the discount to settle $14,000 of the amount.

On November 4, the customer paid the remaining $6,000.


Exercise 5 (1 & 2) and Exercise 6

Merchandise may be returned

by a customer

to a supplier.

A special price

reduction, called an

allowance, may be given

as an incentive to

keep the merchandise.

Sales Returns

To avoid misstating the financial statements, sales revenue and accounts receivable should be

reduced by the amount of returns in the period of sale if the amount of

returns is anticipated to be material.

Accounting for Merchandise Sales

Sales discounts and returns and allowances are Contra Revenue accounts.Sales discounts and returns and allowances are Contra Revenue accounts.

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Sales ReturnsDuring the first year of operations, Hawthorne sold $2,000,000 of merchandise that had cost them $1,200,000 (60%). Industry experience indicates a10% return rate. During the year $130,000 was returned prior to customer payment. Record all necessary Journal Entries including YE adjustment.

Accounts Receivable 2,000,000Sales 2,000,000

Cost of Goods Sold 1,200,000Inventory 1,200,000

Actual ReturnsSales returns (I/S Account) 130,000

Accounts receivable 130,000Inventory 78,000

Cost of goods sold (60%) 78,000Adjusting EntriesSales returns (200,000 – 130,000) 70,000

Allowance for sales returns (B/S Account) 70,000Inventory estimated returns 42,000

Cost of goods sold (60%) 42,000

Sales Returns

Exercise 8

Uncollectible Accounts Receivable

Bad debts result from credit customers who are unable to pay the amount they

owe, regardless of continuing collection efforts.

Bad debts result from credit customers who are unable to pay the amount they

owe, regardless of continuing collection efforts.

In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in

which the sales related to the uncollectible account

were recorded.

In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in

which the sales related to the uncollectible account

were recorded.

Uncollectible Accounts Receivable

Most businesses record an estimate of the bad debt expense by an adjusting entry

at the end of the accounting period.

Most businesses record an estimate of the bad debt expense by an adjusting entry

at the end of the accounting period.

Bad debt expense xxxAllowance for uncollectible accounts xxx

Contra asset account to

accounts receivable.

Normally classified as

a selling expense and

closed at year-end.

Allowance for Uncollectible Accounts

Net realizable value is the amount of the accounts receivable that the business expects to collect.

Accounts ReceivableLess: Allowance for Uncollectible Accounts

Net Realizable Value

Accounts ReceivableLess: Allowance for Uncollectible Accounts

Net Realizable Value

Income Statement Approach

Balance Sheet Approach Composite Rate Aging of Receivables

Income Statement Approach

Balance Sheet Approach Composite Rate Aging of Receivables

Two Methods

1. Percent of Sales Method (Income Statement)

2. Accounts Receivable Methods (Balance Sheet)

Percent of Accounts Receivable Method

Aging of Accounts Receivable Method

Two Methods

1. Percent of Sales Method (Income Statement)

2. Accounts Receivable Methods (Balance Sheet)



Allowance Method of estimating

Bad Debts Expenses

7-56

Barton has credit sales of $1,400,000 in 2009. Management estimates 0.5% of credit sales will eventually prove uncollectible.

What is Barton’s Bad Debts Expense for 2009?

Percent of Sales Method

Bad debts expense is computed as follows:

7-57

Barton’s accountant computes estimated

Bad Debts Expense of $7,000.

Percent of Sales Method

DR CRDec. 31 Bad Debts Expense 7,000

Allowance for Doubtful Accounts 7,000 To record estimated bad debts

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Percent of Sales MethodBarton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on Dec.31, 2009.

What is the balance in AFDA on Dec. 31, 2009?

Prepare the ‘T’ accounts for A/R and AFDA showing the balances as of 12/31/09.

Bal. 100,000Accounts Receivable

Dec. 31 900BDE 7,000Dec. 31 7,900

Allowance for Doubtful Accounts

DR CRCashAccounts receivable 100,000$ Less: Allowance for doubtful accounts 7,900 92,100$

Barton, Co.Partial Balance Sheet

December 31, 2009

Percent of Sales Method(Income Statement Approach)

Exercise 10

Compute the estimate of the Allowance for Doubtful Accounts:

Bad Debts Expense is computed as:


7-61

Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009.

Past experience suggests that 4% of receivables are uncollectible.

What is the balance in AFDA on Dec. 31, 2009?What is Barton’s Bad Debts Expense for 2009?

Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009.

Past experience suggests that 4% of receivables are uncollectible.

What is the balance in AFDA on Dec. 31, 2009?What is Barton’s Bad Debts Expense for 2009?

Percent of Accounts Receivable

7-62

Desired balance in Allowance for Doubtful Accounts.




7-63


DR CRCashAccounts receivable 100,000$ Less: Allowance for doubtful accounts 4,000 96,000$

Barton, Co.Partial Balance Sheet

December 31, 2009

Bal. 100,000Accounts Receivable

Dec. 31 900BDE 3,100Dec. 31 4,000

Allowance for Doubtful Accounts


Exercise 11, 12, 13

Each receivable is grouped by how long it is past its due date.

Each receivable is grouped by how long it is past its due date.

Estimated bad debts for each group are totaled.

Estimated bad debts for each group are totaled.


Each age group is multiplied by its estimated bad debts percentage.

7-66

Barton, Co.Schedule of Accounts Receivable by Age

December 31, 2009

Days Past Due

Accounts Receivable

Balance Percent

Uncollectible

Estimated Uncollectible

Amount

Not Yet Due 64,500$ 1% 645$ 1 - 30 Days Past Due 18,500 3% 555 31 - 60 Days Past Due 10,000 7% 700 61 - 90 Days Past Due 3,900 40% 1,560 Over 90 Days Past Due 3,100 60% 1,860

100,000$ 5,320$

Aging of Accounts Receivable

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Barton’s unadjusted balance in the allowance account is $900.

We estimated the proper balance to be $5,320.

Barton’s unadjusted balance in the allowance account is $900.

We estimated the proper balance to be $5,320.

Aging of Accounts Receivable



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Percent of Accounts Receivable Method (AGING of A/R)

Problem 1, 4(c)

With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts.

With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts.

Writing Off a Bad Debt under the Allowance

Method

Barton determines that Martin’s $300 account is uncollectible.

Barton determines that Martin’s $300 account is uncollectible.

DR CRDec. 31 Allowance for Doubtful Accounts 300

Accounts Receivable - Martin 300 To write-off an uncollectible account

7-70

Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded.

Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded.

Recovery of a Bad Debt

DR CRFeb. 8 Accounts Receivable - Martin 300

Allowance for Doubtful Accounts 300 To reinstate account previously written off

Feb. 8 Cash 300 Accounts Receivable - Martin 300

To record full payment on account

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Summary of Measurement and Reporting Issues for Accounts ReceivableRecognition

Depends on the earnings process; for most credit sales, revenue and the related receivables are recognized at the point of delivery.

Initial valuationInitially recorded at the exchange price agreed upon by the buyer and seller.

Subsequent valuationInitial valuation reduced to net realizable value by:

1. Allowance for sales returns 2. Allowance for uncollectible accounts: The income statement approach The balance sheet approachClassification

Almost always classified as a current asset.

Notes Receivable

A written promise to pay a specificamount at a specific future date.

Even for maturities less than 1 year, the

rate is annualized.

Even for maturities less than 1 year, the

rate is annualized.

Interest-Bearing Notes On November 1, 2014, West, Inc., loans $25,000 to Winn Co.

The note bears interest at 12% and is due on November 1, 2015.

Prepare the journal entry on November 1, 2014, December 31, 2014, (year-end) and November 1, 2015, for West.

November 1, 2014Notes receivable 25,000

Cash 25,000December 31, 2014Interest receivable 500

Interest revenue 500November 1, 2015Cash 28,000

Note receivable 25,000Interest receivable 500Interest revenue 2,500

Interest-Bearing Notes

Exercise 14

Noninterest-Bearing Notes

Actually do bear interest.

Interest is deducted (discounted) from the face value of the note.

Cash proceeds or Sales Value equal face value of note less discount.

Noninterest-Bearing NotesOn Jan. 1, 2014, West, Inc., accepted a $25,000 noninterestbearing note from Winn Co. as payment for a sale. Thenote is discounted at 12% and is due on Dec. 31,2014.Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014.

On Jan. 1, 2014, West, Inc., accepted a $25,000 noninterestbearing note from Winn Co. as payment for a sale. Thenote is discounted at 12% and is due on Dec. 31,2014.Prepare the journal entries on Jan. 1, 2014, and Dec. 31, 2014.

January 1, 2014Notes receivable 25,000

Discount on notes receivable *3,000Sales revenue (Cash) 22,000

*($25,000 * 12% = $3,000)

December 31, 2014Cash 25,000Discount on notes receivable 3,000

Interest revenue 3,000Note receivable 25,000

***Effective Interest Rate = (3,000 / 22,000) = 13.64%

Noninterest-Bearing Notes

Exercise 15

U.S. GAAP vs. IFRS

U.S. GAAP allows a “fair value option” for accounting for receivables.

U.S. GAAP does not allow receivables to be accounted for as “available for sale” investments.

U.S. GAAP requires more disaggregation of accounts and notes receivable in the balance sheet or notes.

In general, IFRS and U.S. GAAP are very similar with respect to accounts receivable and notes receivable. Differences are

highlighted below.

IFRS restricts the circumstances in which a “fair value option” for accounting for receivables is allowed.

Until 2015, companies may account for receivables as “available for sale” investments if the approach is elected initially. After January 1, 2015, this treatment is no longer allowed.

Financing with Receivables (Not Covered)

Companies may use their receivables to

obtain immediate cash.

Factoring Arrangements

FACTOR (Transferee)

SUPPLIER(Transferor)

RETAILER1. Merchandise

2. Accounts Receivable

3. Accounts Receivable

4. Cash5.

Cas

h

A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of thereceivables, and charges a fee for the service.

A factor is a financial institution that buys receivablesfor cash, handles the billing and collection of thereceivables, and charges a fee for the service.

Secured BorrowingOn December 1, 2013, the Santa Teresa Glass Company borrowed $500,000 from Finance Bank and signed a promissory note. Interest at 12% is payable monthly. The company assigned $620,000 of its receivables as collateral for the loan. Finance Bank charges a finance fee equal to 1.5% of the accounts receivable assigned.

Cash (difference) 490,700Finance charge expense (1.5% * $620,000) 9,300

Liability – financing arrangement 500,000

Santa Teresa Glass will continue to collect the receivables, and will record any discounts, sales returns, and bad debt write-offs, but will remit the cash to Finance Bank, usually on a monthly basis. When $400,000 of the receivables assigned are collected in December, Santa Teresa Glass records the following entries.

Cash 400,000Accounts receivable 400,000

Interest expense ($500,000 * 12% * 1/12) 5,000Liability – financing arrangement 400,000

Cash 405,000

Sale of Receivables

Treat as a sale if all of these conditions are met: receivables are isolated from transferor. transferee has right to pledge or exchange

receivables. transferor does not have control over the

receivables. Transferor cannot repurchase

receivable before maturity. Transferor cannot require return

of specific receivables.

Treat as a sale if all of these conditions are met: receivables are isolated from transferor. transferee has right to pledge or exchange

receivables. transferor does not have control over the

receivables. Transferor cannot repurchase

receivable before maturity. Transferor cannot require return

of specific receivables.

Sale of Receivables

Without recourse An ordinary sale of receivables to the factor. Factor assumes all risk of uncollectibility. Control of receivable passes to the factor. Receivables are removed from the books, fair

value of cash and other assets received is recorded, and a financing expense or loss is recognized.

Without recourse An ordinary sale of receivables to the factor. Factor assumes all risk of uncollectibility. Control of receivable passes to the factor. Receivables are removed from the books, fair

value of cash and other assets received is recorded, and a financing expense or loss is recognized.

With recourse Transferor (seller) retains risk of uncollectibility. If the transaction fails to meet the three conditions

necessary to be classified as a sale, it will be treated as a secured borrowing.

With recourse Transferor (seller) retains risk of uncollectibility. If the transaction fails to meet the three conditions

necessary to be classified as a sale, it will be treated as a secured borrowing.

Sale of ReceivablesIn December 2013, the Santa Teresa Glass Company factored accounts receivable that had a book value of $600,000 to Factor Bank. The transfer was made without recourse. Under this arrangement, Santa Teresa transfers the $600,000 of receivables to Factor, and Factor immediately remits to Santa Teresa cash equal to 90% of the factored amount (90% × $600,000 = $540,000). Factor retains the remaining 10% (estimated to have a fair value of $50,000) to cover its factoring fee (equal to 4% of the total factored amount; 4% × $600,000 = $24,000) and to provide a cushion against potential sales returns and allowances.

Assume the same facts as above, except that Santa Teresa Glass sold the receivables to Factor with recourse and estimates the fair value of the recourse obligation to be $5,000.

Sale of Receivables

Securitization: Transfer receivables to a SPESpecial Purpose Entity (SPE)

Qualifying Special Purpose Entity (QSPE)New rules eliminate QSPE and require

consolidation! Participating Interests: Transfer portion of

a receivableExample: transfer right to interest, but

retain right to principalNew rules require a partial transfer be treated as a secured borrowing, unless

specific conditions are met!

Interest receivable 5,000Interest revenue 5,000

Transfers of Notes ReceivableOn December 31, Stridewell accepted a nine-month 10

percent note for $200,000 from a customer. Three months later on March 31, Stridewell discounted the note at its local bank. The bank’s discount rate is 12 percent.

$200,000 × 10% × 3/12

Before preparing the journal entry to record the discounting, Stridewell must record the accrued interest on the note

from December 31 until March 31.

Transfers of Notes Receivable

Cash 202,100Loss on sale of note receivable 2,900

Notes receivable 200,000Interest receivable 5,000

$205,000 $202,100

Deciding Whether to Account for a Transfer as a Sale or a Secured Borrowing

U.S. GAAP vs. IFRS

U.S. GAAP focuses on whether control of assets has shifted from the transferor to the transferee.

The U.S. GAAP and the IFRS approaches often lead to similar accounting treatment for transfers

of receivables.

IFRS requires a more complex decision process. The company has to have transferred the rights to receive the cash flows from the receivable, and then considers whether the company has transferred “substantially all of the risks and rewards of ownership,” as well as whether the company has transferred control.

This ratio measures how many times a company converts its

receivables into cash each year.

Net Sales Average Accounts Receivable

ReceivablesTurnover

Ratio=

This ratio is an approximation of the number of days the average accounts

receivable balance is outstanding.

365 Receivables Turnover Ratio

Average Collection

Period=

Receivables Management

Symantec Corp. vs. CA, Inc., comparisonSymantec Corp. vs. CA, Inc., comparison

2011 2010 2011 2010Accounts receivable (net) 1,013$ 856$ 849$ 931$ Net sales 6,190 4,429

Symantec Corp. CA, Inc.2011 2010 2011 2010

Accounts receivable (net) 1,013$ 856$ 849$ 931$ Net sales 6,190 4,429

Symantec Corp. CA, Inc.

Receivables Management

(All dollar amounts in millions)

Symantec Corp CA, Inc Industry AverageReceivables turnover 6.62 4.98 5.96 Average collection period 55.14 days 73.29 days 61.3 days

Symantec Corp CA, Inc Industry AverageReceivables turnover 6.62 4.98 5.96 Average collection period 55.14 days 73.29 days 61.3 days

When a company holds a receivable from another company, there is some potential that

the receivable will eventually be impaired.

Impairment of a receivable occurs if the company believes

it is probable that it will not receive all of the cash flows (principal and any interest

payments) associated with the receivable.

Appendix 7-B: Accounting for Impairment of a Receivable and a Troubled Debt Restructuring


Bad debt expense 8,867,670Accrued interest receivable 3,000,000Allowance for uncollectible accounts 5,867,670

($30,000,000 - $24,132,330)


A troubled debt restructuring occurs when a creditor makes concessions in response to a debtor’s financial difficulties.

(in millions)Land (fair value) 20Bad debt expense 13

Accrued interest receivable 3Notes receivable 30

Sometimes a receivable in a troubled debt restructuring is actually settled at the time of the restructuring by the debtor making a payment of cash, some other noncash assets, or even shares of the debtor’s stock.

U.S. GAAP vs. IFRS

Under U.S. GAAP the level of analysis is individual receivables.

U.S. GAAP provides an illustrative list of information to consider when evaluating receivables for impairment, and requires measurement of potential impairment if impairment (a) is viewed as probable and (b) can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of impairments the same.

The U.S. GAAP and the IFRS approaches to impairments of receivables are similar, but the process and criteria are

somewhat different.

Under IFRS the level of analysis starts with consideration of impairment for individually significant receivables.

IFRS provides an illustrative list of “loss events” and requires measurement of an impairment if there is objective evidence that a loss event has occurred that has an impact on the future cash flows collected and that can be estimated reliably.

Both U.S. GAAP and IFRS treat reversal of impairments the same.

End of Chapter 7

Cash and Receivables Chapter 7. Learning Objectives 1. Define internal control and describe some key elements of an internal control system for cash receipts.

Documents

cash cash equivalents

cash equivalents cash

known cash

cash receipts

cash discounts

coins cash equivalents

cash equivalents shortterm

cash equivalents balances