Fundamentals of Intermediate Accouting

Weygandt, Kieso, and Warfield

Chapter 7: Cash and Receivables

Prepared by
Bonnie Harrison, College of Southern Maryland
LaPlata, Maryland
 Chapter 7
Cash and Receivables
After studying this chapter, you should be able to:
Identify items considered cash.
Indicate how cash and related items are reported.
Define receivables and identify the different types
of receivables.
Explain accounting issues related to recognition
of accounts receivable.
Explain accounting issues related to valuation of
accounts receivable.
 Chapter 7
Cash and Receivables
After studying this chapter, you should be able to:
Explain accounting issues related to recognition of
notes receivable.
Explain accounting issues related to valuation of
notes receivable.
Explain accounting issues related to disposition of
accounts and notes receivable.
Explain how receivables are reported and analyzed.
 Part 1:
Cash
and Cash Equivalents
 Cash and Cash Equivalents: Issues

Definition of cash
: various items that comprise cash.
Management and control of cash
: the importance of internal control of cash
Reporting of cash in the balance sheet
 Items Comprising Cash
Cash must be readily available and be free
of restrictions
Cash consists of coins, currency and available
funds
Deposits (CDs) and short term paper are
classified as temporary investments
Post dated checks, travel advances and stamps
on hand are not classified as cash
 Management and Control of
Cash
Since cash is the most liquid asset, internal
control of cash is imperative.
Controls must prevent unauthorized use of
cash
Management must have necessary
information for proper use of cash
 Reporting of Cash
The reporting of cash depends upon
whether it is:
1 restricted cash
2 a bank overdraft or
3 a cash equivalent
 Restricted Cash
Compensating balances:
are amounts maintained by a corporation with
a bank in support of existing borrowing
arrangements.
are identified as current assets separate from
cash, if they relate to short- term loans.
are identified as non-current assets separate
from cash, if they relate to long-term loans.
 Bank Overdrafts
Overdrafts represent checks written in
excess of cash account.
Overdrafts may be offset against available
cash in another account in the same bank.
Otherwise, such offsetting is not allowed.
An overdraft should be reported as a current
liability.
 Cash Equivalents
Short term highly liquid investment
(original maturities of three months or less)
Readily convertible to known amounts of
cash AND
So near maturity they present insignificant
risk of changes in interest rates.
 Part 2:
Accounts Receivable
 Accounts Receivable: Issues
Types of accounts receivable
: current and non-current
: trade and non-trade
Recognition of accounts receivable in the
financial statements - cash discounts / interest
Valuation of accounts receivable
: estimated bad debts and net realizable value
Disposition of receivable - transfers / sale
 Accounts Receivable:
Recognition
Trade or quantity discounts are not
recorded in books of account.
Cash (sales) discounts are inducements to
customers for prompt payment of
amounts billed.
Cash discounts are recorded in books as
reductions of sales revenue.
Accounts Receivable: Recording Cash
Discounts
There are two methods: Gross and Net
Gross method records A/R at the gross
amount of sale and records discounts when
taken.
Net method records A/R at the net amount
of the sale and captures sales discounts
when not taken.
 Accounts Receivable: Recording Cash Discounts

GROSS method NET method

Record revenue at Record revenue at
gross amount of sales gross amount of sales
less cash discount
When customer takes When customer
the discount, record forfeits discount,
cash discounts record discounts not
taken.
Cash discounts reduce Report discounts not
gross sales revenue taken as other revenue
 Valuation of Accounts Receivable

Short term receivables are reported at their

net realizable value (NRV)
The NRV is the net amount expected to be
collected
The NRV is gross accounts receivable less
estimated uncollectible accounts.
 Estimating Uncollectible Receivables
Methods

Direct Write-Off Allowance

1 Not based on the matching
principle
2 Accounts are written off
when determined uncollectible
3 Appropriate only if
amounts are not material
Based on the matching
principle
Estimated bad debts are
matched against revenue
Must be followed if
amounts are material
 Estimating Uncollectible Accounts:
the Allowance Method
The estimate of uncollectible accounts may
be based on:
1 Percentage of sales OR
2 Percentage of outstanding receivables
These approaches are referred to as Income
statement and Balance sheet approaches
 The Allowance Method (Sales
method-first year)
Indcom Company reports the following
balances for the year 2003 (first year):
Net Sales: $50,000
Accounts Rec (Dec 31, 2003): $4,600
The company estimates bad debts at 2% of
net sales.
Determine estimated uncollectible accounts
expense for 2003.
 The Allowance Method (Sales Method -
First Year)
1 Est. uncollectible accounts (bad debts) expense:
$50,000 * 2% = $1,000

2 To record bad debts expense:

Estimated bad debts expense $1,000
Allowance for Uncollectible
accounts $1,000
Bad debts expense Allowance
2003: $1,000 closed $1,000
 The Allowance Method (Sales
Approach-Second year)
Indcom Company reports the following
balances for the year 2004 (second year):
Net Sales: $70,000
Accounts Rec (Dec 31,2004): $5,700
The company estimates bad debts at 2% of
net sales.
Determine estimated uncollectible accounts
expense for 2004.
 The Allowance Method (Sales Method -
Second Year)
1 Est. uncollectible accounts (bad debts) expense:
$70,000 * 2% = $1,400

2 To record bad debts expense:

Estimated bad debts expense $1,400
Allowance for Uncollectible
accounts $1,400
Bad debts expense Allowance
2004: $1,400 closed 2003: 1,000
2004: 1,400

Note: No accounts were written off during the year

 The Allowance Method (Acct
Rec Approach-First Year)
Indcom Company reports the following
balances for the year 2003 (first year):
Net sales: $50,000
Accounts Rec (Dec 31,2003): $4,600
The company estimates bad debts at 10% of
accounts receivable.
Determine estimated uncollectible accounts
expense for 2003.
 The Allowance Method (Acct Rec
Approach - First Year)
1 Est. uncollectible accounts (bad debts) expense:
$4,600 * 10% = $460

2 To record bad debts expense:

Estimated bad debts expense $460
Allowance for Uncollectible
accounts $460
Bad debts expense Allowance
2003: $ 460 closed $ 460
 The Allowance method (Acct
Rec approach-second year)
Indcom Company reports the following
balances for the year 2004 (second year):
Net Sales: $70,000
Accounts Rec (Dec 31, 2004): $5,700
The company estimates bad debts at 10% of
accounts receivable.
Determine estimated uncollectible accounts
expense for 2004.
 The Allowance Method (Acct Rec Approach -
Second Year)
1 Est. uncollectible accounts (bad debts) expense:
$5,700 * 10% = $ 570 (required)
less: existing allowance = ($ 460)
Bad debts expense (2004) = $110

2 To record bad debts expense:

Estimated bad debts expense $110
Allowance for Uncollectible
accounts $110
**You must take into account the balance in Allowance for
Uncollectible Accounts**
 The Allowance Method (Acct Rec
Approach - Second Year)

Bad debts expense Allowance

2004: $ 110 closed $ 460
$ 110
$ 570

Adjusting entry: Required

Bad Debts expense $110 ending
Allowance account $ 110 allowance
 Balance Sheet Representation

Short term accounts receivable are shown at

their net realizable value as follows:
Accounts Receivable (gross) : $ XXX
less: Allowance : ($ XX)
Net Realizable Value : $ XX
 Part 3:
Notes Receivable
 Notes Receivable: Issues

Recognition of Notes Receivable

issues at face value and issues not at
face value
issues for cash / non-cash considerations
Valuation issues
Disposition of notes receivable
 Recognition of Notes Receivable
Notes Receivable

Short term N/R Long term N/R

Record at face value Record at present value

less Allowance of cash expected to
be collected

Issues at par Issues not at par

 Recognition of Notes Receivable

Notes receivable are issued at face value

when the stated rate of interest is the same
as the effective (market) rate.
When the rates are unequal, a discount on
the note results.
The discount is amortized to interest
revenue by the effective interest method.
 Recognition of Notes Receivable
Issues NOT at face value
Non interest bearing
1. Determine discount on
notes receivable at
implicit rate of interest
2. The discount is
amortized to interest
revenue by the
effective interest
method
Interest bearing
1. Determine discount on
notes receivable at
the effective rate of
interest.
2. The discount is
amortized to interest
revenue by the
effective interest
method
 Discount on notes receivable:
Example
Assume Debrief Company issues a notes
receivable (FV= $10,000) on 1/1/2003.
Stated Rate, 10%; Effective Rate, 12%
The discount is $480.
Assume that the discount to be amortized
for 2003 is $ 142.
Show necessary journal entries.
 Discount on notes receivable:
Example
1/1/2003:
Notes Receivable $10,000
Discount (N/R) $ 480
Cash $ 9,520
December 31, 2003:
Discount (N/R) $ 142
Cash $ 1,000
Interest Revenue $1,142
 Part 4:
Disposition of Accounts
and
Notes Receivable
 Disposition of Accounts and
Notes Receivable
The holder of accounts or notes receivable may
transfer them for cash.
The transfer may be:
secured borrowing or
a sale of receivables
Holder retains ownership of receivables in a
secured borrowing transaction.
Holder transfers ownership of receivables in a sale
(transfers risks of collection)
 Transfer of Receivables:
Borrowing vs. Sale Treatment
Conditions
1. Are transferred assets isolated
from transferor? and
Yes Sale
2. Does transferee have right to
pledge or sell assets? and
3. Has transferor divested itself of
control through repurchase No Borrowing
agreement?

**All three conditions must be met for a sale to occur**

Accounting for Transfers of Receivables
Transfers

Secured Borrowing Sale

With Recourse Without Recourse

Continuing involvement No continuing

by involvement by
seller seller
 Secured Borrowing (highlights)
Transferor records a finance charge.
Transferor collects accounts receivable.
Transferor records sales returns and sales
discounts.
Transferor absorbs bad debts expense.
Transferor records interest expense on notes
payable.
Transferor pays on the note periodically from
collections.
 Sales of Receivables(highlights)
Transferor transfers ownership of receivables to
factor.
Factor records the (transferred) accounts as assets in
its books.
Transferor records any amount retained by transferee
as due from factor
Transferor records loss on sale of receivables
Transferor records any recourse liability (when
appropriate)
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